Re-examining Purchasing Power Parity for East-Asian Currencies: 1976-2002

Barumshah, Ahmad Zubaidi and Chan, Tze-Haw and Fountas, Stilianos (2004): Re-examining Purchasing Power Parity for East-Asian Currencies: 1976-2002. Forthcoming in: Applied Financial Economics

Abstract

We investigate the behavior of real exchange rates of six East-Asia countries in relation to their two major trading partners – the US and Japan. These countries, Singapore excepted, were affected by the financial crisis of the fall 1997. Using monthly frequency data from 1976 to 2002 and the ARDL cointegration procedure we test for the long-run PPP hypothesis. We find no evidence for the weak form of PPP in the pre-crisis period but strong evidence in the post-crisis period. For the post-crisis period, we also find very small persistence of PPP deviations as indicated by very small half-lives (less than 7 months) and narrow confidence intervals with an upper bound of 1 year or less in most countries. Our findings reveal that the East Asian countries are returning to some form of PPP-oriented rule as a basis for their exchange rate policies.

• Item Type: MPRA Paper
• Institution: Universiti Putra Malaysia
• Language: English
• Keywords: Purchasing power parity; Asian financial crisis; bounds test; half-lives; confidence intervals
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F40 - General; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C23 - Panel Data Models ; Spatio-temporal Models; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C12 - Hypothesis Testing: General

References

Aggarwal, R., A. Montana and M. Ponz (2000) Evidence of Long-Run Purchasing Power Parity: Analysis of Real Asian Exchange Rates in terms of the Japanese Yen, Japan and the World Economy, 351-361. Azali, M., M.S. Habibullah and A.Z. Baharumshah (2001) Does PPP hold between Asian and The Japanese Economies? Evidence Using Panel Unit Root and Panel Cointegration, Japan and the World Economy, 13, 35-50. Baharumshah, A.Z. and M. Ariff (1997) Purchasing Power Parity in South East Asian Countries: A Cointegration Approach, Asian Economic Journal, 11, 141-154. Baharumshah, A.Z., E. Lau, and S. Fountas (2003) On the sustainability of current account deficits: evidence from four ASEAN countries, Journal of Asian Economics, 14, 465-487. Bahmani-Oskooee, M., (1993) Purchasing Power Parity Based on Effective Exchange Rate and Cointegration; 25 LDCs Experience with its Absolute Formulation, World Development, 21, 1023-31. Chinn, M.D. (2000) Before the Fall: Were East Asian Currencies Overvalued? Emerging Markets Review, 1, 101-126. Choudhry, T. (2005) Asian Currency Crisis and the Generalized PPP: Evidence from the Far East, Asian Economic Journal, 19(2), 137-157. Diebold, F.X., S. Husted and M. Rush (1991) Real Exchange Rates Under the Gold Standards, Journal of Political Economy, 99, 1252-1271. Dornbusch, R. (1982) PPP Exchange Rates Rules and macroeconomic stability, Journal of Political Economy, 90, 158-65. Dumas, B. (1992) Dynamic Equilibrium and the Real Exchange Rates in a Spatially Separated World, Review of Financial Studies, 5, 153-180. Elliott, G., T. Rothenberg, and J.H. Stock (1996) Efficient Tests for an Autoregressive Unit Root, Econometrica, 64, 813-836. Enders, W. and S. Hurn (1994) Common Trends and Generalized Purchasing Power Parity, Mathematics and Computers in Simulations, 43, 437-43. Frenkel, J.A. (1976) A monetary approach to the exchange rate: Doctrinal Aspects and Empirical evidence, Scandinavian Journal of Economics, 78, 200-224. Frenkel, J.A. (1980) Purchasing Power Parity: Doctrinal Aspects and Empirical evidence from the 1920s, Journal of International Economics, 8, 169-191. Froot, K.A. and K. Rogoff, (1995) Perspective on PPP and Long-run Real Exchange Rates. In: Grossman, G., Rogoff, K. (Eds.), Handbook of International Economics, Vol. 3. Elsevier Press, Amsterdam, pp. 1648-1684. Gross, D. (1986). Wage Indexation and the Real Exchange Rate in Small Open Economies, International Monetary Fund Staff Papers, 33, 117-38. Kremers, J. J., N. R. Ericsson, and J. J. Dolado (1992). The power of cointegration tests, Oxford Bulletin of Economics and Statistics, 54, 325-347. Liew, V. K., A.Z. Baharumshah, T. T. Chong (2004) Are Asian real exchange rates stationary? Economics Letters, 83, 313-316. Liu, P., (1992) Purchasing Power Parity in Latin America: A Cointegration Analysis, Weltwirtschaftliches Archiv, 128, 662-80. Lopez, C., C. J. Murray and D.H. Papell (2003) State of the Art Unit Root Tests and the PPP Puzzle, Working Paper, Department of Economics, University of Houston. Lopez, C., C. J. Murray and D.H. Papell (2005) State of the Art Unit Root Tests and Purchasing Power Parity, Journal of Money, Credit and Banking, 37, 361-370. Lothian, J.R. and M.P Taylor (1996) Real Exchange rate Behaviour: The Recent Float from the Perspective of the Past Two Centuries, Journal of Political Economy, 104, 488-509. McNown, R. and M. Wallace, (1989) National Price Level, Purchasing Power Parity, and Cointegration: A test of Four High Inflation Economies, Journal of International Money and Finance, 8, 533-45. Mark, N. (2001) International Macroeconomics and Finance: Theory and empirical methods, Blackwell Publishers. Mollick, A.V., (1999) The Real Exchange Rate in Brazil: Mean Reversion or Random Walk in the Long run? International Review of Economics and Finance, 8, 115-126. Murray, C.J., and D.H. Papell (2002) The Purchasing Power Parity Persistence Paradigm, Journal of International Economics, 56, 1-19. Mussa, M., (1986) Nominal Exchange Rate Regimes and the Behavior of Real Exchange Rates: Evidence and Applications, Carnegie Rochester Series on Public Policy, 25, 117-213. Ng, S. and P. Perron (2001) Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power, Econometrica, 69, 1519-1554. O’Connell, P., (1998) The Overvaluation of Purchasing Power Parity, Journal of International Economics, 44, 1-19. Ogawa, E. and K. Kawasaki (2003) Possibility of Creating a Common Currency Basket for East Asia, Discussion Paper No.5 JBIC Institute, Tokyo, Japan. Papell, D.H. (1997) Searching for Stationarity: Purchasing Power Parity under the Current Float, Journal of International Economics, 43, 313-332. Papell, D.H. (2002) The Great Appreciation, The Great Depreciation, and The Purchasing Power Parity, Journal of International Economics, 57, 51-82. Patel, J. (1990) Purchasing Power Parity as a Long run Relation, Journal of Applied Econometrics, 5, 367-379. Pesaran, M.H., and Y. Shin, (1995) An Autoregressive Distributed Lag Modelling Approach to Cointegration Analysis, DAE Working Paper no 9514, Department of Applied Economics, University of Cambridge. Pesaran, M.H., Y. Shin and R.J. Smith (2001) Bounds Testing Approach to the Analysis of Level Relationships, Journal of Applied Econometrics, 16, 289-326. Rogoff, K. (1996) The Purchasing Power Parity Puzzle, Journal of Economic Literature, 34, 647-668. Rossi, B. (2005) Confidence Intervals for Half-Life Deviations from Purchasing Power Parity, Journal of Business and Economics Statistics, 23, 432-442. Taylor, A. M. (2002). A century of Purchasing Power Parity, Review of Economics and Statistics, 84, 139-150. Taylor, A. M. and M. P. Taylor, 2004. The Purchasing Power Parity debate, Journal of Economic Perspectives, 18, 135-158. Taylor, M. P. and D. A. Peel (2000). Nonlinear adjustment, long-run equilibrium and exchange rate fundamentals, Journal of International Money and Finance, 19, 33-53. Wu, Y., (1996). Are Real Exchange Rates Nonstationary? Evidence form a Panel-data Test, Journal of Money, Credit and Banking, 28, 54-63.