Purchasing power parity and real exchange rate in Central Eastern European countries

This study applies a non-linear threshold unit-root test to test the validity of purchasing power parity (PPP) to assess the non-stationary properties of the convergence of real exchange rates (RERs) based on Taylor rules for ten Central Eastern European countries. We find that the non-linear threshold unit-root test has greater power than the linear method suggested by Caner and Hansen (2001) if the true data generating process of RER convergence is a stationary non-linear process. We examine the validity of Taylor rules from the non-linear perspective and provide robust evidence that clearly indicates that PPP holds true for seven Central Eastern European countries. These results imply that the choices and effectiveness of the monetary policies in Central Eastern European economies are highly influenced by external factors that originate from the United States. Additionally, our findings highlight that these countries' RER convergence is a mean reversion towards the equilibrium values of Taylor rules in a non-linear manner. Our findings mean capital mobility, exchange rate market efficiency and monetary integration are non-linear in these Central Eastern European countries.