Purchasing Power Parity: Long and Short-Run Testing

  • Ronald MacDonald
  • Ian Marsh
Part of the Advanced Studies in Theoretical and Applied Econometrics book series (ASTA, volume 37)

Abstract

A useful starting point for our discussion in this chapter, and the next, is figure 3.1, which features the real and nominal exchange rates of a number of currencies for the recent floating period. The striking feature of this figure is the very close correlation between real and nominal exchange rates (indeed the average correlation coefficient across the six countries portrayed in figure 3.1 is in excess of 0.7, or 0.8 excluding Italy). This immediately makes the point that purchasing power parity cannot hold on a short-run basis. But does it hold in the long-run? There is some evidence to suggest that it does not, so one important theme in any discussion of the economics of exchange rates concerns trying to quantify the importance of relative prices in explaining nominal exchange rate movements. That is one of the themes considered in this chapter. As we shall see, much of this debate focuses on the magnitude of mean reversion in real exchange rates and, in particular, explaining why it is so slow.

Keywords

Exchange Rate Unit Root Real Exchange Rate Unit Root Test Purchase Power Parity 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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Copyright information

© Springer Science+Business Media Dordrecht 1999

Authors and Affiliations

  • Ronald MacDonald
    • 1
  • Ian Marsh
    • 2
  1. 1.University of StrathclydeUK
  2. 2.City University Business SchoolUK

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