Purchasing Power Parity in transition economies: evidence from the Commonwealth of Independent States

Abstract

This article tests the validity of Purchasing Power Parity (PPP) for Commonwealth of Independent States (CIS) countries. For this purpose we test whether the real exchange rate series of 10 CIS countries vis-à-vis the US dollar follow a stationary process. Considering the fact that the CIS countries have undergone major structural changes during the transition period, in addition to conventional unit root tests, we employ recently developed unit root tests that allow for structural breaks and non-linearities. When possible structural changes and non-linearities are not taken into account, the null hypothesis of unit root is rejected only in two out of 10 series. However, allowing for structural breaks and/or non-linearities in the data generating process results in more rejection of the null hypothesis of unit root. All in all, our results provide evidence in favour of the PPP hypothesis in these transition countries.

Notes

1. See for example Rogoff (1996), Sarno and Taylor (2002), Taylor (2002) and Taylor (2003) for recent surveys.

2. The Commonwealth of Independent States (CIS) was created in December 1991 among Belarus, Russia and Ukraine after the collapse of the Union of Soviet Socialist Republics. The CIS now comprises 12 members: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.

3. Explanations for such a severe recession include (i) disorganisation or breakdown of the economic relations of the old regime, (ii) collapse of the arms industry and state-financed investment in housing, energy, agriculture and infrastructure, (iii) credit market imperfections, (iv) massive and rapid changes in relative prices, (v) the huge amount of obsolete fixed capital in inefficient enterprises and the low quality of domestically produced goods. For a thorough discussion of causes of recession in transition economies see Blanchard (1997), Gomulka (2000) and Campos and Coricelli (2002).

4. Blanchard (1997) and Roland (2000) provide overviews of the reforms in transition economies.

5. For a thorough discussion of smooth transition regression models see Granger and Teräsvirta (1993).

6. Frankel (1990) argues that while a researcher may not be able to reject the null hypothesis of unit root, it does not necessarily mean that researcher must then accept that hypothesis. For this purpose we also applied the KPSS stationarity test due to Kwiatkowski et al. (1992). The KPSS test differs from the ADF in that the former assumes that the series under investigation are stationary under the null hypothesis. With a linear trend in the KPSS the null hypothesis of stationarity is rejected for all except the Tajik series, suggesting that PPP holds only for Tajikistan. The results of the KPSS tests are available upon request.

7. In addition to the LNV test, we also applied the Zivot and Andrews (1992) unit root test, which assumes an abrupt break in the data. Using the Zivot and Andrews (1992) structural break test, we were able to reject the null hypothesis of unit root in five cases, namely Armenia, Belarus, Kyrgyzstan, Moldova and Russia. In order to save space, we do not report the results here; they are available upon request.