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Re-evaluating whether absolute or relative purchasing power parity is being tested when using price indices

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  • Stewart, Chris

    (Kingston University London)

Abstract

A growing body of research suggests that the literature applying unit root, stationarity and cointegration tests of long run purchasing power parity (PPP) and the law of one price (LOP) with price index data test relative PPP/LOP and not absolute PPP/LOP. We argue that such tests cannot determine when long run relative PPP/LOP is rejected and therefore are not tests of relative PPP/LOP. These are not tests of strong absolute PPP/LOP either. We contend that they are tests of weaker forms of absolute PPP/LOP and that determining which form of absolute PPP/LOP is useful in terms of, for example, establishing the form of long run flexible-price monetary exchange rate model that it implies.

Suggested Citation

  • Stewart, Chris, 2023. "Re-evaluating whether absolute or relative purchasing power parity is being tested when using price indices," Economics Discussion Papers 2023-1, School of Economics, Kingston University London.
    • Handle: RePEc:ris:kngedp:2023_001
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    More about this item

    Keywords

    absolute purchasing power parity; relative purchasing power parity; the law of one price; price indices; unit root tests; cointegration tests; flexible-price monetary exchange rate models.;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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