Revisiting Purchasing Power Parity in OECD

Abstract

This study revisits Purchasing Power Parity theory (PPP) in the 34 OECD countries during January 1994–August 2013. We use a new panel stationary test with both sharp breaks and smooth shifts, a novel approach to panel unit-root testing, proposed by Bahmani–Oskooee et al. (2014). The results indicate that the PPP holds in half of the 34 OECD countries. These results indicate the importance of proper modelling of both sharp breaks and smooth shifts in real effective exchange rate series of OECD countries.

Keywords:

• Purchasing Power Parity
• OECD countries
• panel stationary test
• sharp breaks and smooth shifts
• Fourier function

JEL Classification:

• C22
• F31

Acknowledgement

Valuable comments of two anonymous referees are greatly appreciated. Remaining errors, however, are our own.

Notes

¹  The study by Enders and Holt (2012) is the first study that discusses sharp breaks or smooth shifts in investigating the evolution of primary commodity prices.

² Because we only test shifts of the drift term, we are also testing the validity of Quasi-/Qualified – PPP (or Q-PPP). They are similar in concept as discussed by Ventosa-Santaulària and Gómez-Zaldívar (2013).

³ The exceptions are Estonia, Norway and Slovenia in which PPP is supported by the ADF and PP tests.

⁴ Maximum number of breaks and frequencies are fixed at 10 for each country.

⁵ For some other PPP and exchange rate related studies see Ahking (1997), Apergis (1998), Arize et al. (2003), Baffoe-Bonnie (2004), Beach et al. (1993), Bleaney (1992), Bwo-Nung (1996), Carrión-i-Silvestre et al. (2004), Enders and Chumrusphonlert (2004), Hojman (1989), Holmes (2002), Horne (2004), Jenkins (2004), Jung (1995), Macdonals (2002), Moosa (1994), Nachane (1997), Narayan (2005), Peel and Venetis (2003), Sjölander (2007)and Baharumshah and Borsic (2008).