Purchasing Power Parity: A Time Series Analysis of the U.S. and Mexico, 1995 - 2007
This paper investigates the classic purchasing power parity (PPP) relationship between the United States and Mexico during the 1995 – 2007 period. It utilizes the Johansen and Juselius multivariate cointegration method to test three models for the existence of PPP in both its absolute and relative forms. The first model determines that the ratio of U. S. PPI to Mexican PPI can be treated as a single variable. This provides indirect evidence for absolute PPP in the long run. However, a lack of suitable data in the second model prevents further cointegration tests that could directly examine this relationship. The third model tests for relative PPP by imposing restrictions on both the cointegrating equation and adjustment coefficients of the VECM. It finds that relative PPP holds closely in the long run, but the short run results are ambiguous. Despite the relatively short time span, this paper lays the empirical basis for future tests of PPP between the U.S. and Mexico.
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