Purchasing power parity in Central and Eastern European countries: an analysis of unit roots and nonlinearities

Abstract

The aim of this article is to analyse the empirical fulfilment of purchasing power parity (PPP) in a number of Central and Eastern European countries. For this purpose we apply two different unit root tests in order to control for two sources of nonlinearities, i.e. Bierens (1997) and Kapetanios et al. (2003). We find that PPP holds in most of these countries once account has been taken of nonlinear deterministic trends and smooth transitions.

Acknowledgements

The author gratefully acknowledges the useful comments provided by David Cushman, Dean Garratt and Stephen Heasell, the financial support from the CICYT and FEDER project SEJ2005-01163, the Bancaja project P1.1B2005-03 and the Generalitat Valenciana Complementary Action ACOMP07/102. The author is a member of the INTECO research group. The usual disclaimer applies. The IVIE is also acknowledged.

Notes

¹ Units of foreign currency for a unit of domestic currency.

² While the absence of stochastic trends is a necessary condition for PPP to hold, the existence of a time trend or broken time trend can be considered as a weak form of PPP or quasi-PPP (Hegwood and Papell, 1998).

³ From the beginning of the sample to December, 1999 we have used the ECU exchange rates. After this date, the Euro exchange rate is used.

⁴ See Ng and Perron (2001) for further details.

Table 2.  Ng and Perron (2001) unit root tests results

⁵ The process is globally stationary provided that −2 < φ < 0.

⁶ Following Bierens (1997) the use of Chebishev polynomials instead of regular time polynomials (Ouliaris et al., 1989) to approximate the nonlinear deterministic trend creates less power distortions.