Does the purchasing power parity theory hold for Malaysia ?

Madeira, Makharam and Masih, Mansur (2017): Does the purchasing power parity theory hold for Malaysia ?

Abstract

Originally propounded by the sixteenth-century scholars of the University of Salamanca, the concept of purchasing power parity (PPP) was revived in the interwar period in the context of the debate concerning the appropriate level at which to re-establish international exchange rate parities. Broadly accepted as a long-run equilibrium condition in the post-war period, it was first advocated as a short-run equilibrium by many international economists in the first few years following the breakdown of the Bretton Woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s. This study is also embarking on the same quest to check for the purchasing power parity between Malaysia and US using a monthly data over 12 years. To look at the relation between Domestic Price in Malaysia, Foreign Price of the US and Exchange Rate between the Ringgit and the Dollar from these two nations, a standard time series technique was applied. Empirical results tend to indicate that there is a cointegrating relationship among exchange rates, Malaysia price level and US price level and that the PPP holds in that the three variables adjust to equilibrium in the long run. The implication for the policy makers is that the movement should have no effect on the relative competitive position of domestic or foreign firms, as competitiveness will depend on the real exchange rate.

• Item Type: MPRA Paper
• Language: English
• Keywords: PPP, VECM, VDCs, Malaysia
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

References

Khan, Arshad and Abdul Qayyum (2008), Long-Run and Short-Run Dynamics of the Exchange Rate in Pakistan: Evidence From Unrestricted Purchasing Power Parity Theory, The Lahore Journal of Economics, 13(1), 29-56.

Coakley, Jerry, Robert Flood, Ana Fuertes and Mark Taylor (2004). Purchasing power parity and the theory of general relativity: the first tests, Journal of International Money and Finance 24(2), 293–316.

Bergin, Paul, Reuven Glick and Alan M. Taylo. (2004). Productivity, Tradability, and The Long-Run Price Puzzle. Working Paper Series no. 10569, National Bureau of Economic Research, June.

Cheung, Yin-Wong, Menzie Chinn and Eiji Fujii (2001). Market Structure and the Persistence of Sectoral Real Exchange Rates. International Journal of Finance and Economics. 6(2), 95–114.

Flood, Robert and Andrew K. Rose (1995). Fixing Exchange Rates: A Virtual Quest for Fundamentals. Journal of Monetary Economics. 36 (1), 3–37.

Masih, Mansur, I. Algahtani and Lurion DeMello (2010) Price Dynamics of Crude Oil and Regional Ethylene Markets, Energy Economics, 32 (6), 1435 – 1444.

Masih, Mansur, M. Alsahlawi and Lurion DeMello (2010) What Drives Carbon-Dioxide Emissions : Income or Electricity Generation ? Evidence from Saudi Arabia , Journal of Energy and Development 33 (2), 201 –213

Papell, D. (1997), Searching for Stationarity: Purchasing Power Parity under the Current Float , Journal of International Economics, 43, 313-320.

Papell, D.H. and H. Theodoridis (1998), Increasing Evidence of Purchasing Power Parity over the Current Float, Journal of International Money and Finance, 17, 41-50.

Patel, J. (1990), Purchasing Power Parity as a long-run relation , Journal of Applied Econometrics, 5, 367-369

Salehizadeh, M. and R. Taylor (1999), A Test of Purchasing Power Parity for Emerging Economies, Journal of International Financial Markets, Institutions and Money, 9, 183-193.

Sarno, L. and M.P. Taylor (1998), Real Exchange Rates under the Recent Float: Unequivocal Evidence of Mean Reversion, Economics Letters, 60, 131-137.

Sideris D. (1997), Multilateral versus bilateral testing for long-run Purchasing Power Parity: A cointegration analysis for the Greek drachma', European University Institute working papers, ECO No. 97/18.

Taylor, M.P. (1988), An Empirical Examination of Long-Run Purchasing Power Parity Using Cointegration Techniques , Applied Economics, 20, 1369-1381.

Xu, Z. (1999), The exchange rate and long-run price movements in the US and Japan , Applied Economics Letters, 6, 227-230.