Theory and Tests of Generalized Purchasing‐Power Parity: Common Trends and Real Exchange Rates In the Pacific Rim

Abstract

AbstractThe paper develops the theory of generalized purchasing‐power parity (G‐PPP) to explain the “stylized facts” of real exchange‐rate behavior. the fundamental economic variables determining real exchange rates are nonstationary; thus, real rates are nonstationary. If the fundamentals are sufficiently integrated, as in a currency area, the real rates will share common trends. the theory is tested using the Pacific Rim nations. It is shown that G‐PPP holds between each of the Pacific Rim nations and the large industrialized countries. There is only mild evidence that G‐PPP holds among the Pacific Rim nations as a group.