Nonlinear adjustment to purchasing power parity for Germany's real exchange rate relative to its major trading partners

Abstract

This study applies a simple and powerful nonlinear unit-root test proposed by Sollis (2009) to test the validity of long-run Purchasing Power Parity (PPP) for Germany's real exchange rate vis-à-vis its trading partner countries. The empirical results indicate that PPP holds for Germany relative to its major trading partners, with the exception of Canada, and the adjustment towards PPP is nonlinear and asymmetric. This result provides support for PPP for Germany relative to its major trading partner countries.

Keywords:

• nonlinear unit-root test
• purchasing power parity
• Germany

JEL Classification:

• C22
• F31

Notes

¹For details on previous studies, please refer to the works of Taylor (1995), Rogoff (1996), MacDonald and Taylor (1992), Taylor and Sarno (1998), Sarno and Taylor (2002), Taylor and Taylor (2004) and Lothian and Taylor (2000, 2008), who have provided in-depth information on the theoretical and empirical aspects of Purchasing Power Parity (PPP) and the Real Exchange Rate (RER).

²The RER series of a country at time t is define as , where S_t is the nominal exchange rate of home country per Mark, and denote the Consumer Price Indices (CPI) of home country and Germany, respectively.

³For detailed discussion, see Sollis (2009, p. 121).