Does the purchasing power parity theory hold for Malaysia ?

Originally propounded by the sixteenth-century scholars of the University of Salamanca, the concept of purchasing power parity (PPP) was revived in the interwar period in the context of the debate concerning the appropriate level at which to re-establish international exchange rate parities. Broadly accepted as a long-run equilibrium condition in the post-war period, it was first advocated as a short-run equilibrium by many international economists in the first few years following the breakdown of the Bretton Woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s. This study is also embarking on the same quest to check for the purchasing power parity between Malaysia and US using a monthly data over 12 years. To look at the relation between Domestic Price in Malaysia, Foreign Price of the US and Exchange Rate between the Ringgit and the Dollar from these two nations, a standard time series technique was applied. Empirical results tend to indicate that there is a cointegrating relationship among exchange rates, Malaysia price level and US price level and that the PPP holds in that the three variables adjust to equilibrium in the long run. The implication for the policy makers is that the movement should have no effect on the relative competitive position of domestic or foreign firms, as competitiveness will depend on the real exchange rate.