The purchasing power parity in Australia: evidence from unit root test with structural break

Abstract

The unit root test with structural break developed by Perron and Rodriguez are used to study the purchasing power parity (PPP) in the spirit of Balassa–Samuelson in Australia for the period January 1977 to April 2004. The results indicate that there is a break in February 1985 which coincides with the exchange rate crisis in 1985, occurring after the establishment of the dirty flexible exchange rate system. We also show that there is no tendency to the PPP in Australia to hold in the long-run during this period.

Acknowledgements

We would like to thank Gabriel Rodriguez for his Gauss program, and the anonymous referee for his helpful comments. Any remaining errors are ours. The views expressed herein are those of the authors and do not necessarily reflect those of the Banque de France.

Notes

¹ For a survey of PPP literature, see Froot and Rogoff (1995), Taylor and Taylor (2004) and Taylor (2006).

² More precisely, this concept of PPP is often termed absolute PPP. Relative PPP is said to hold when the rate of depreciation of one currency relative to another matches the difference in aggregate price inflation between the two countries concerned.

³ Here, we focus on Balassa–Samuelson effects from a linear trend. An alternative suggested by Lothian and Taylor (2000) could be from a nonlinear trend.

⁴ Indeed, we found that the deterministic trend is significant in the Australian real exchange rate.

⁵ TRAMO: Time Series Regression with ARIMA Noise, Missing Observations and Outliers (Gómez and Maravall, 1997). See Tolvi (2001) for detailed discussion on the outlier detection procedure.

⁶ PR (2003) also extended the unit root test developed by Elliott et al. (1996).

⁷ Vogelsang (1999) showed that the NP test is robust to the presence of AOs.