Abstract
The purpose of the paper is to evaluate the validity of purchasing power parity (PPP) for eight countries from the Emerging Europe: Hungary, Czech Republic, Poland, Romania, Lithuania, Latvia, Serbia and Turkey. Monthly data for euro and U.S. dollar based real exchange rate time series are considered covering the period: January, 2000 - August, 2011. Given significant changes in these economies in this sample it seems plausible to assume that real exchange time series are characterized by more than one time structural break. In order to endogenously determine the number and type of breaks while testing for the presence of unit roots we applied the Lee-Strazicich approach. For two euro based real exchange rate time series (in Hungary and Turkey) the unit root hypothesis has been rejected. For the U.S. dollar based real exchange rate time series in Poland, Romania and Turkey the presence of unit root has been rejected. To assess the adjustment dynamics of those real exchange rates that were detected to be stationary with two breaks, the impulse response function is calculated and half-life is estimated. Our overall conclusion is that the persistence of real exchange rate in Emerging Europe is still substantially high. The lack of strong empirical support for PPP suggests that careful policy actions are needed in this region to prevent serious exchange rate misalignment.
Highlights
The first part of this section presents euro and U.S dollar based time series of real exchange rates, after which we outlined the results of unit root tests that do not involve structural breaks in the analysis
This paper investigates the sustainability and validity of purchasing power parity (PPP) theory in the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Serbia and Turkey in the period from early 2000 to August 2011
The empirical results obtained by standard unit root tests (ADF, KPSS and DF-GLS) indicate a very high level of persistence in time series of real exchange rates in the observed countries, with the exception of the established stationarity of euro based real exchange rate in the case of the Turkish economy
Summary
Different approaches to testing the validity of the PPP theory can be classified into two groups, depending on the tests used: (1) testing the stationarity of time series of the real exchange rate; (2) identifying the cointegration relationship between the nominal exchange rate and the relative prices. The results of applying the tests which take into account the presence of structural breaks in the analysis indicate that only the time series of Romania and Bulgaria accepted the alternative hypothesis and long-term accordance with purchasing power parity, while the theory itself remains a controversial issue. Marked non-stationarity of time series real exchange rate in the Czech Republic, Hungary and Slovenia in the period 1992-2006 is featured in the work of Jani Beko and Darja Boršić (2007), and further analysis revealed the unsustainability of the PPP theory for the above economies. The empirical results of the application of unit root tests in the work Athanasios Papadopoulos and Nikolaos Giannellis (2006) indicate the acceptance of the PPP theory in four selected economies (Hungary, Poland, Czech Republic and Slovakia). Kutan (2001) present similar empirical results, in the sense that nominal shocks had a dominant influence on the movement of the real exchange rate in Poland, while for Hungary the real changes had more prominent effect
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