Revisiting purchasing power parity for nine transition countries: a Fourier stationary test

Abstract

This study applies the stationarity test with a Fourier function proposed by Becker et al. to test the validity of long-run purchasing power parity (PPP) in a sample of transition countries from January 1995 to December 2008. The empirical results indicate that PPP does not hold for most of the transition countries studied, with the exception of Lithuania. Our results have important policy implications for these transition countries.

Acknowledgement

The authors thank the anonymous referee for several helpful comments and suggestions which they believe have made the article more valuable and readable. Any errors that remain are our own.

Notes

1. Here we use a KPSS-type stationarity test since tests with the null of a unit root have low power with stationary but persistent data. The problem of low power is exacerbated when a theory, such as purchasing power parity or the convergence of growth rates across nations, can be more naturally tested under the null of stationarity. Stationarity tests are also useful to confirm results from unit-root tests with a stationary alternative.

2. In our study we consider only a specification with a constant but without a time trend because a time trend in real exchange rates is not consistent with long-run PPP; therefore we estimate only Equation (5).

3. In other words, omission of policy effects is crucial in PPP testing as they tend to bias tests of PPP against its acceptance. Sideris (2008) also argues that omission of intervention effects–when they are significant–would bias the ability to detect any PPP-based behaviour of the real exchange rate in the long run. He finds positive evidence for this argument from the experience of six Central and East European economies (Bulgaria, Poland, Romania, Russia, Slovenia and Ukraine), whose exchange markets are characterised by frequent intervention.