Price Regulation, Exchange Rate Regulation and the Purchasing Power Parity: Empirical Evidence from China

ABSTRACT

This paper compiles a market-based price index by accounting for the impact of price regulation. We then use the parallel market exchange rate and market-based price index to test Purchasing Power Parity (PPP) over a more extended period (1952–2019) in China. We find weak evidence support PPP when official data are used. However, we fail to find evidence against PPP when the parallel market exchange rate and the market-based price index are used. Moreover, the half-life of the RMB real exchange rate is approximately one year, substantially lower than the consensus estimates of 3–5 years.

KEYWORDS:

• Price regulation
• exchange rate regulation
• purchasing power parity

JEL:

• F31
• F41
• N25

Supplementary material

Supplemental data for this article can be accessed online at https://doi.org/10.1080/1540496X.2023.2281414

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Data availability statement

The data that support the findings of this study are available (Appendix A, Table A2).

Notes

1. For further discussion on the reasons for PPP failure, see Appendix A.

2. For more detail about variable description and data source, see Table A2.

3. The village fairs trade price index is an indicator that reflects the price of commodities in village fair trade. It includes two parts: consumer goods and agricultural production materials.

4. There are two data sources in the village fairs trade price index and the market-based price index for the following reasons. First, with the gradual liberalization of price regulation, the official price index after 1993 can reflect the actual market price. Second, previous data sources no longer match the economic reality (such as the diversification of business forms and the decline in the transaction volume of village fair trade). Therefore, the change in data sources is in line with the process of economic system transformation. Third, the model applied in this article can allow changes in price indices.

5. We compare the differences between official nominal exchange rate and parallel market exchange rate in Appendix D.

6. Kim and Perron’s (2009) structural break unit root test using the MATLAB codes downloaded from Perron’s homepage: http://people.bu.edu/perron.

7. For more details, see Appendix I.

Additional information

Funding

This research was supported by The National Social Science Fund of China [grant number 19BJL131]; and National Natural Science Foundation of China [grant number 71973109].