Purchasing Power Parity: Evidence from Selected High and Low Inflation Countries

Yusuf Haji-Othman,Sani Yahaya

doi:10.5539/ibr.v8n1p50

Abstract

This paper reexamines the long run relationship between nominal bilateral exchange rate and the price index ratio for high and low inflation countries using time series analysis techniques. Tests for non-stationarity were carried out before cointegration analysis was conducted. Theoretically, Purchasing Power Parity (PPP) should receive empirical support in the case of high-inflation countries. This is because PPP is a monetary phenomenon and monetary factors tend to overshadow real factors in high-inflation countries. The findings show that high inflation countries such as Sierra Leone and Mexico support the Theory of Purchasing Power Parity (PPP). In the case of low inflation countries, none of the countries provides evidence supporting theory of PPP.

Highlights

The purpose of this paper is to reexamine long run equilibrium in exchange rate and to establish empirical evidence on the possible long run relationship between nominal bilateral exchange rate and price index ratio for selected high and low inflation countries
This study can be justified as follows: i) it differs from most of earlier studies, as it focuses on sample from the high and low inflation countries, ii) By adopting the cointegration method, the problem of spurious regression is avoided as only non stationary variables will be proceeded for the estimation. iii) The findings of this study provide the empirical evidence that for high inflation countries such as Sierra Leone and Mexico the theory of Purchasing Power Parity (PPP) do hold and for low inflation countries, it does not hold
One can observes that there exists a long run relationship between exchange rate and purchasing power

Summary

Introduction

The purpose of this paper is to reexamine long run equilibrium in exchange rate and to establish empirical evidence on the possible long run relationship between nominal bilateral exchange rate and price index ratio for selected high and low inflation countries. Since time series data are used, the possibilities of spurious regression relationships among variables exist unless an appropriate statistical test of long run relationship takes into account important characteristics of time series data. The DF and ADF test are used to check whether all variables are non-stationary followed by the cointegration analysis. This study can be justified as follows: i) it differs from most of earlier studies, as it focuses on sample from the high and low inflation countries, ii) By adopting the cointegration method, the problem of spurious regression is avoided as only non stationary variables will be proceeded for the estimation. This study can be justified as follows: i) it differs from most of earlier studies, as it focuses on sample from the high and low inflation countries, ii) By adopting the cointegration method, the problem of spurious regression is avoided as only non stationary variables will be proceeded for the estimation. iii) The findings of this study provide the empirical evidence that for high inflation countries such as Sierra Leone and Mexico the theory of PPP do hold and for low inflation countries, it does not hold

Objectives

Methods

Results

Conclusion