Exchange rates and purchasing power parity: the case of Central European

Abstract

Introduction. The question of how exchange rates adjust is central to exchange rate policy, since countries with fixed exchange rates need to know what the equilibrium exchange rate is likely to be and countries with variable exchange rates would like to know what level and variation in real and nominal exchange rates they should expect. In broader terms, the question of whether exchange rates adjust toward a level established by purchasing power parity helps to determine the extent to which the international macroeconomic system is self-equilibrating Analysis of recent researches and publications has shown that the published up to date papers aren’t systematic and can’t claim to be a complete analysis in the chosen field. The aim is to test the validity of PPP hypothesis in the long run in former and current European transitional economies. Methods. General scientific methods such as the systematic approach, theo­retical generalization and comparison, analysis, synthesis and the Levin–Lin–Chu (LLC) panel unit root test have been used in the research. Research results. This paper tests the validity of purchasing power parity (PPP) hypothesis in the long run in selected European transitional economies. The database used in this paper contains monthly data on real effective exchange rate (REER) observed over 23 years, from March 1995 till November 2017. To test the hypothesis, the Levin–Lin–Chu (LLC) panel unit root test was employed. The results confirm that PPP holds both for Central European and Western Balkan states in the long run. Conclusions. The equilibrium exchange rate question is central question to exchange rate policy. Purchasing power parity hypothesis was tested on the sample of 14 European countries form the Central and Eastern Europe and Western Balkan region. The database used in this paper contains monthly data on real effective exchange rate –REER observed over 23 years, from March 1995 till November 2017. As PPP holds if the real exchange rate reverts to its equilibrium value over time, the unit root test was applied on panel REER dataset. The results of applied Levin–Lin–Chu (LLC) panel unit root tests confirmed that the PPP hypothesis holds for selected countries during the observed period. Additionaly, results confirmed that PPP hypothesis holds both for CEE and Western Balkan countries separately.