Is the Relationship Between Prices and Exchange Rates Homogeneous?

Stephen Hall, George Hondroyiannis, Amangeldi Kenjegaliev (), P.A.V.B. Swamy and George Tavlas

No 13/13, Discussion Papers in Economics from Division of Economics, School of Business, University of Leicester

Abstract: Empirical tests of purchasing power parity (PPP) are implicitly based on the conditions of symmetry and proportionality of the price coefficients. We investigate a separate condition, which we term homogeneity. Specifically, while there may be factors that drive a wedge between prices and exchange rates, when these factors are held constant we would expect a change in exchange rates to be associated with a proportional, or homogeneous, change in prices. To test for the existence of homogeneity in prices, we conduct two experiments. First, we apply a time-varying-coefficient procedure to nine euro-area countries as well as the euro area as a whole during the (monthly) sample period, 1999: M1 to 2011:M3. Second we apply the same procedure to the same group of countries, plus Canada, Japan and Mexico, over the longer period, 1957:M4 to 2011:M3. We find that averages of the price coefficients, corrected for specification biases, are uniformly homogeneous in the long run, providing strong support for PPP.

Keywords: Purchasing power parity; symmetry; proportionality; homogeneity; generalized cointegration; time-varying coefficients. (search for similar items in EconPapers)
JEL-codes: C32 F31 (search for similar items in EconPapers)
Date: 2013-07
New Economics Papers: this item is included in nep-mon and nep-opm
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Citations: View citations in EconPapers (15)

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