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Is there a rule of thumb for absolute purchasing power parity to hold?


  • Zhang, Zhibai


We find an example where real exchange rate (RER) is stationary and the nominal exchange rate and the price levels are cointegrated but purchasing power parity (PPP) does not hold, which reveals a fault of the unit root and cointegration tests in this use. We argue that the distribution of an RER misalignment can be used in testing absolute PPP. Then we apply this new test and the coefficient restriction test to study the validity of absolute PPP in 40 main countries and areas (versus the US) in light of the Harrod-Balassa-Samuelson effect. The econometric proofs show that absolute PPP holds or closely holds in most countries when their averaged relative GDP per capita (GDPPs, against the US with the US = 1) are greater than 0.7. And it does not hold in almost all countries when their averaged GDPPs are smaller than 0.7. Thus, a rule of thumb for the theory to hold is that the GDPP should be above 0.7.

Suggested Citation

  • Zhang, Zhibai, 2014. "Is there a rule of thumb for absolute purchasing power parity to hold?," MPRA Paper 55338, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:55338

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    References listed on IDEAS

    1. Edison, Hali J. & Gagnon, Joseph E. & Melick, William R., 1997. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 1-17, February.
    2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    3. Engel, Charles, 2000. "Long-run PPP may not hold after all," Journal of International Economics, Elsevier, vol. 51(2), pages 243-273, August.
    4. Astorga, Pablo, 2012. "Mean reversion in long-horizon real exchange rates: Evidence from Latin America," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1529-1550.
    5. Frenkel, Jacob A., 1981. "The collapse of purchasing power parities during the 1970's," European Economic Review, Elsevier, vol. 16(1), pages 145-165.
    6. Pedroni, Peter, 2004. "Panel Cointegration: Asymptotic And Finite Sample Properties Of Pooled Time Series Tests With An Application To The Ppp Hypothesis," Econometric Theory, Cambridge University Press, vol. 20(03), pages 597-625, June.
    7. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-1042, November.
    8. Chang, Tsangyao & Lee, Chia-Hao & Liu, Wen-Chi, 2012. "Nonlinear adjustment to purchasing power parity for ASEAN countries," Japan and the World Economy, Elsevier, vol. 24(4), pages 325-331.
    9. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
    10. Cheung, Yin-Wong & Chinn, Menzie D. & Pascual, Antonio Garcia, 2005. "Empirical exchange rate models of the nineties: Are any fit to survive?," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1150-1175, November.
    11. Chang, Tsangyao & Tzeng, Han-Wen, 2011. "Long-run purchasing power parity with asymmetric adjustment: Further evidence from nine transition countries," Economic Modelling, Elsevier, vol. 28(3), pages 1383-1391, May.
    12. Ito, Takatoshi, 1997. "The Long-Run Purchasing Power Parity for the Yen: Historical Overview," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 502-521, December.
    13. Peter Isard, 2007. "Equilibrium Exchange Rates; Assessment Methodologies," IMF Working Papers 07/296, International Monetary Fund.
    14. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
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    More about this item


    Absolute purchasing power parity; Real exchange rate; RER misalignment distribution test; Harrod-Balassa-Samuelson effect;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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