The Growing Evidence on Purchasing Power Parity

The explosion of research on the topic of purchasing power parity (PPP) since the 1970s is testimony to the theory’s undoubted appeal as a method for exchange rate determination. Indeed, the concept of PPP has endured some controversial findings in the empirical literature to become even more popular over the past decade, as the use of more sophisticated econometric techniques has evolved. Notably, the application of unit root and cointegration tests dominated the literature during the 1990s, with the majority of studies finding support for PPP for both developed and developing countries. However, doubts about the ‘power’ of these tests have given rise to debate over the veracity of using time-series data versus cross-sectional, or panel, data. Meanwhile, The Economist’s Big Mac Index has been another catalyst for PPP research over the past decade, with its easy accessibility and international appeal. Empirical tests of exchange rate behaviour, using the Index, have been surprisingly successful in proving the PPP condition, and have encouraged a school of research using this metric.