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A Reexamination of Purchasing Power Parity: A Multicountry and Multiperiod Study

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  • Craig S. Hakkio

Abstract

This paper presents a systematic analysis of the purchasing power parity hypothesis (PPP). This hypothesis states that the exchange rate is equal to the ratio of the domestic price level to the foreign price level. It has recently been argued that PPP performs poorly in the 1970s. This paper examines several possible explanations for this poor performance . We examine PPF in the 1920s and the 1970s, using monthly and quarterly data, to see if the relationship has changed over time. We also examine PPP in a multi-exchange rate world, allowing a quite general error process so as to allow deviations from PPP to be autocorrelated and correlated across currencies. We are then able to examine the degree to which the world has become more interdependent. We also provide evidence that deviations from PPP may follow a random walk. Finally, the role of the U.S. dollar as base currency is examined. We find, in general, that PPP holds quite well as a long run proposition, but the deviations from PPP tend to persist.

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  • Craig S. Hakkio, 1982. "A Reexamination of Purchasing Power Parity: A Multicountry and Multiperiod Study," NBER Working Papers 0865, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0865
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    1. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-853, October.
    2. Hakkio, Craig S, 1981. "Expectations and the Forward Exchange Rate," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 22(3), pages 663-678, October.
    3. Michael R. Darby, 1981. "Does purchasing power parity work?," Proceedings, Federal Reserve Bank of San Francisco, issue 5, pages 136-173.
    4. Hakkio, Craig S, 1982. "Exchange Rate Determination and the Demand for Money," The Review of Economics and Statistics, MIT Press, vol. 64(4), pages 681-686, November.
    5. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-1072, June.
    6. Frenkel, Jacob A., 1978. "Purchasing power parity : Doctrinal perspective and evidence from the 1920s," Journal of International Economics, Elsevier, vol. 8(2), pages 169-191, May.
    7. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 143-206.
    8. Lawrence H. Officer, 1982. "The Purchasing-Power-Parity Theory of Gerrard de Malynes," History of Political Economy, Duke University Press, vol. 14(2), pages 256-259, Summer.
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