Testing purchasing power parity: a look to the evidence from six different territories. From period 1970-2021

Abstract

[eng] The theory of the Purchasing Power Parity states that “the exchange rate between the currencies of two countries is equal to the ratio between the price levels of those countries so that a unit of currency of one country will have the same purchasing power in a foreign country” (Alan M. Taylor, and Mark P. Taylor, 2004, p.135). The purpose of this work is to study the validity of the different versions of the Purchasing Power Parity (PPP) for a sample of six different currencies covering the period from 1970 to 2021 using monthly data for long-span real consumer price indexes. I have employed two different methods to study the existence of Relative and Absolute Purchasing Power Parities. The first one is a Unit Root test to check if the Relative version of the PPP holds, by testing if the difference between each country’s CPI series with respect to the USA’s CPI series are stationary. The second one is a Cointegration test to validate the Absolute version of the PPP. Additionally, I have complemented the study by obtaining the Impulse Response Functions to keep track of the response given by each country’s CPI to external changes in the USA’s CPI.