Evidence on PPP from a cointegration test with multiple structural breaks

Abstract

Despite a plethora of studies on purchasing power parity (PPP), those that take a cointegration approach have found mixed evidence on PPP. The goal of this article is to obviate existing tensions in the PPP literature by using a simple test for cointegration between nominal exchange rate and relative prices that accounts for multiple structural breaks. We find that for 14 out of 15 OECD countries, there is evidence of a cointegration relationship between nominal exchange rate and relative prices at the 5% level. Only for Japan, we find evidence for cointegration at the 2.5% level. These results suggest overwhelming evidence of support for PPP for the OECD countries.

Notes

¹ For work on a nonlinear approach to modelling PPP, see Sarno and Taylor (2001), Taylor et al. (2001); Taylor (2004, 2005, 2006); Taylor and Taylor (2004).