Measuring Misalignment: PPP and East Asian Currencies in the 1990's

Abstract

The concept of purchasing power parity (PPP) is used as an equilibrium exchange rate measure to evaluate whether eight East Asian currencies were overvalued on the eve of the 1997 currency crises: Hong Kong dollar, Indonesian rupiah, Korean won, Malaysian ringgit, Philippine peso. Singapore dollar, Taiwanese dollar and the Thai baht. Using both the Johansen and Horvath-Watson cointegration test procedures, the purchasing power parity tests are performed on bilateral (US$, yen) and multilateral exchange rates, using consumer price indices, producer price indices, and price indices of export goods. The second deflator yields the greatest evidence of stationarity. I find that the Hong Kong dollar, ringgit, Philippine peso, and baht were overvalued as of May 1997, according to the PPP criterion, while the won and the New Taiwan dollar were substantially undervalued. The implied deviations are compared against those obtained using simple trends in consumer price index deflated real rates; these trend based calculations typically suggest larger overvaluations than their producer price deflated counterparts.