Generalized purchasing power parity, real exchange rates, and structural changes in the Indonesian economy

Abstract

This research has investigated the validity of Purchasing Power Parity (PPP) and Generalized-PPP in the presence of structural change for the Association of Southeast Asian Nations (ASEAN) countries, the ASEAN group and each of its major trading partners--the US, Japan, and Germany, and the major trading partners and each of the ASEAN countries and also South Korea. Another objective of this research is to study the short-run dynamic of Generalized-PPP and the interrelationships among real exchange rates in a currency area in the sense of Generalized-PPP. Real exchange rate series, in which Indonesia is a base country, have constructed using whole sales price index, whole sales price without oil for Indonesia and consumer price index and nominal exchange between Indonesia and country studies. The series start from January 1974 to October 1992;Based on the study of the policy and the performance of the reforms, the March 1983 was chosen as the breaking point for Indonesia economy. This structural change is accounted for all empirical studies in this research. The unit root test in the presence of structural change (Perron, 1989) has applied to test the validity of PPP. Empirical findings do not support PPP for all country studies. The validity of Generalized-PPP has investigated using Johansen's (1988) multivariate cointegration method. Some of the empirical results support the existence of Generalized-PPP;Error correction models have estimated for the group in which Generalized-PPP is held. Structural change dummy and error correction variables, mostly, were supported by empirical results. Interrelationships among real exchange rates in a currency area are studied applying impulse response functions and forecast error variance decomposition. Monte Carlo simulation was conducted for providing standard error bounding of impulse response. The findings suggest that the US real exchange rate has stronger influence on the ASEAN real exchange rates and South Korean real exchange rate than that of Japanese real exchange rate. Among ASEAN real exchange rates, Singapore real exchange rate shown a stronger influence.