PPP: a disaggregated view

Fischer, Curt R.

doi:10.1080/09603100500389218

Cited by 5 publications

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“…The alternative approach of Fischer (2004) maintains that real exchange rates, by definition, consist of two components, the first of which is the real exchange rate for a single good that should be stationary because of the law of one price. The second component is a weighted sum of relative prices between different goods which has no reason to be stationary.…”

Section: Discussionmentioning

confidence: 99%

“…Interestingly, Fischer (2004) shows that an alternative, less well-known argument against the validity of PPP, which has been put forward inter alia by Hsieh (1982), Devereux (1997) and Driver/Westaway (2005), implies a two-component structure of real exchange rates similar to that proposed by Engel (2000). In fact, the real exchange rate, by definition, consists of the real exchange rate of a single good and a weighted sum of relative prices between different goods.…”

Section: Introductionmentioning

confidence: 95%

“…Nominal exchange rates are taken from the IMF's International Financial Statistics. 4 The dataset is explained in more detail in Fischer (2004). The data have been used to compute x it , y it , and q it according to equations (1), (8), and (9).…”

Section: Construction Of the Two Components From The Data And An Econmentioning

confidence: 99%

“…Then, the real exchange rate by definition exhibits the two-component structure from a more economic perspective, such a "solution" may be the least plausible one, first, because it implies that PPP holds although the LOP does not and in spite of relative price trends. Second, there is no economic rationale for the two components to be cointegrated, let alone with a particular cointegrating vector (see Fischer, 2004).…”

Section: Introductionmentioning

confidence: 99%

“…In order to become more specific, consider the simple assumption consistent with both Engel's (2000) and Fischer's (2004) approaches that the stationary component is an AR (1) process while the non-stationary component follows a random walk. Expressed in terms of equation (7), 1 Two mechanisms that should maintain PPP have been put forward in the literature.…”

Section: Introductionmentioning

confidence: 99%

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A reappraisal of the evidence on PPP: a systematic investigation into MA roots in panel unit root tests and their implications

Fischer

Porath

2009

Empir Econ

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Abstract:Panel unit root tests of real exchange rates -as opposed to univariate tests -usually reject non-stationarity. These tests, however, could be biased if the real exchange rate contained MA roots. Indeed, two independent arguments claim that the real exchange rate, being a sum of a stationary and a non-stationary component, is possibly an ARIMA (1, 1, 1) process. Monte Carlo simulations show, how systematic changes in the parameters of the components, of the test equation and of the correlation matrix affect the size of first and second generation panel unit root tests. Two components of the real exchange rate, the real exchange rate of a single good and a weighted sum of relative prices, are constructed from the data for a panel of countries. Computation of the relevant parameters reveals that panel unit root tests of the real exchange rate are severely oversized, usually much more so than simple ADF tests. Thus, the evidence for PPP from panel unit root tests may be merely due to extreme size biases. Keywords:panel unit root test, purchasing power parity, real exchange rate, Monte Carlo simulation JEL-Classification: F31, C33 Non Technical SummaryIn the last fifteen years, the empirical validity of purchasing power parity (PPP) over the post-Bretton Woods period has been studied extensively. As regards the methodology, unit root tests have been used to investigate whether the real exchange rate is stationary or not. While panel unit root tests usually confirm purchasing power parity, univariate unit root tests reject the PPP hypothesis in most cases. Since they combine information from several time series, panel unit root tests display greater power than univariate unit root tests. For this reason, the issue of whether purchasing power parity holds is widely held to be settled in favour of PPP.The evidence presented in this study challenges conventional wisdom. It is shown that unit root tests are biased in favour of a rejection of the non-stationarity null if they are applied to a variable that is the sum of two components, one of which is stationary Two arguments from the literature are presented, both of which suggest independently that the real exchange rate consists of two such components. Based on one of the theoretical arguments, the data from the OECD's structural analysis database are used to construct the two components for eleven industrial countries. Consistent with the theory, panel unit root tests show that one of the series can be considered stationary, whereas the other most probably is non-stationary. The parameters of the two component model are estimated. For both this particular parameter constellation as well as one taken from the literature, the bias which occurs when panel unit root tests are applied to real exchange rates is determined by using Monte Carlo simulations.It turns out that panel unit root tests of real exchange rates are biased quite substantially in favour of a rejection of the non-stationarity null if a two-component structure is assumed. The large body of empirica...

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Section: Discussionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 95%

Section: Construction Of the Two Components From The Data And An Econmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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A reappraisal of the evidence on PPP: a systematic investigation into MA roots in panel unit root tests and their implications

Fischer

Porath

2009

Empir Econ

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Is reversion to PPP in euro exchange rates non-linear?

Schnatz

2007

IEEP

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Non-technical summary Terms of use: Documents in EconStor mayThe wide fluctuations in the euro exchange rate since its launch in 1999 call for a deeper understanding of the underlying relationships. From a policy perspective, it is particularly useful to understand of whether and when exchange rate changes constitute movements towards or away from some long-term equilibrium level. While there are various ways to think about equilibrium exchange rates, this paper focuses on the universal starting point of applied exchange rate analysis which is to compare the current exchange rate against some measure of purchasing power parity (PPP). In its relative version, PPP states that nominal exchange rates move in proportion to relative developments in domestic and foreign prices implying a constant real exchange rate. While visual inspection seems to support that the euro real exchange rates oscillate around a mean in the long run, more rigorous statistical tests commonly fail to confirm such mean reverting properties.This finding should not lead us to the conclusion to discard drawing inferences from PPP analysis. Several caveats caution against a too strict interpretation of such tests of PPP. These include the lack of power of the tests themselves, the real exchange rate interaction with economic fundamentals (such as different trends in productivity) and the presence of nonlinearities in the mean reversion process. This paper investigates the latter aspect.Non-linearities in the adjustment of exchange rates can be justified from both a goods and a financial market perspective. As international goods arbitrage involves transaction costs, arbitrage sets in once the real exchange rate protractedly moves outside certain limits. From an asset market perspective, differing trading strategies could play a role with "Chartists" dominating market dynamics when the exchange rate is close to some perceived equilibrium, while "Fundamentalists" being at play once the exchange rate is increasingly misaligned.Appling this concept to the euro, the presence of such non-linear behaviour is confirmed for the real effective exchange rate of the euro and the two bilateral euro exchange rates with the biggest weight in the euro effective exchange rate, namely the real euro-dollar and the real euro-pound sterling exchange rates. Specifically, using a smooth transition autoregressive (STAR-) model, we find that the further away the real exchange rate moves from PPP, the stronger th...

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Gaps galore in the monetary approach to the purchasing power parity: a theoretical note

Subrahmanyam

Reddy

2019

Macroeconomics and Finance in Emerging Market Economies

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PPP: a disaggregated view

Cited by 5 publications

References 39 publications

A reappraisal of the evidence on PPP: a systematic investigation into MA roots in panel unit root tests and their implications

A reappraisal of the evidence on PPP: a systematic investigation into MA roots in panel unit root tests and their implications

Is reversion to PPP in euro exchange rates non-linear?

Gaps galore in the monetary approach to the purchasing power parity: a theoretical note

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