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Purchasing Power Parity and Real Exchange Rates in Case of Developing Countries

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  • Murat Doganlar
  • Mehmet Ozmen

Abstract

Purchasing power parity states that changes in the nominal exchange rates should reflect the inflation differences. This indicates that if nominal exchange rate changes reflect home and foreign inflation differences, then real exchange rate should remain unchanged. Recent time series econometrics techniques can test this proposal. If the real exchange rate series contain a unit root, then the series are told to be nonstationary which means that PPP (Purchasing power parity) does not hold. Augmented Dickey Fuller and Phillips-Perron unit root tests are used to test the stationarity of the real exchange rate series. The real exchange rate is defined in terms of both United States consumer prices and industrialized countries’ consumer prices. This study is conducted for the period 1986.1-1997.4 for 18 developing countries. The countries under consideration are Bolivia, Chile, Mexico, Ecuador, Uruguay, Costa Rica, Dominican Republic, Jamaica, Morocco, Ghana, Nigeria, India, Indonesia, S. Korea, Pakistan, Philippines, Sri Lanka, and Turkey. Unit root test results indicate that none of the real exchange rate series are stationary for these countries. Therefore, it can be claimed that PPP does not hold for these countries when PPP is defined in terms of real exchange rate.

Suggested Citation

  • Murat Doganlar & Mehmet Ozmen, 2000. "Purchasing Power Parity and Real Exchange Rates in Case of Developing Countries," Istanbul Stock Exchange Review, Research and Business Development Department, Borsa Istanbul, vol. 4(16), pages 91-102.
    • Handle: RePEc:bor:iserev:v:4:y:2000:i:16:p:91-102
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    References listed on IDEAS

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    1. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
    2. Cuddington, John T. & Liang, Hong, 2000. "Purchasing power parity over two centuries?," Journal of International Money and Finance, Elsevier, vol. 19(5), pages 753-757, October.
    3. Cheung, Yin-Wong & Lai, Kon S., 1998. "Parity reversion in real exchange rates during the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 597-614, August.
    4. Eric J. Pentecost, 1993. "Exchange Rate Dynamics," Books, Edward Elgar Publishing, number 355.
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    Cited by:

    1. Mohsen Bahmani‐Oskooee & Scott W. Hegerty, 2009. "Purchasing Power Parity In Less‐Developed And Transition Economies: A Review Paper," Journal of Economic Surveys, Wiley Blackwell, vol. 23(4), pages 617-658, September.
    2. Ibrahim Chowdhury, 2004. "Purchasing Power Parity and the Real Exchange Rate in Bangladesh: A Nonlinear Analysis," Working Paper Series in Economics 14, University of Cologne, Department of Economics.

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