How Sure Are We About purchasing power parity (PPP)? Panel Evidence with the Null of Stationary Real Exchange Rates

Abstract

For purchasing power parity (PPP) to hold in the long run, real exchange rates must be stationary. The aim of this article is to judge the extent to which PPP holding can be thought of, given the problems in statistical decision making that are inherent in testing. This article presents evidence on mean reversion in industrial countries` real exchange rates in a setup that accounts naturally for cross-sectional dependence, is invariant to the benchmark currency, and actually tests for the null of interest, that is, purchasing power parity. The results are based on the Kwiatkowski et al. (1992) test for the stationarity null generalized in a multivariate random walk plus noise model by Nyblom and Harvey (2000).