Decline in the persistence of real exchange rates, but not sufficient for purchasing power parity

Abstract

The paper investigates the possibility of decline in the persistence of real exchange rates, or deviations from PPP. To this end, we test the null hypothesis of no decline in the PPP deviation persistence between two subsamples using a fractional integration framework. The test rejects the null at the 10% significance level for nine out of 17 countries, providing solid evidence for a decline in the persistence of real exchange rates. However, the decline is not sufficient for PPP, meaning we fail to reject the unit root hypothesis even in the latter period for all 17 countries. In addition, our rolling-window estimates show that the real exchange rate of many countries have experienced a sharp drop in their persistence once we use samples starting from the mid-1980s. Finally, we examine the relationship between the dynamics of PPP deviation persistence and several economic variables and confirm that the speed of convergence of PPP deviations is highly related to economic/financial integration and world economic stabilization.