Purchasing Power Parity and Real Exchange Rates in Case of Developing Countries

Purchasing power parity states that changes in the nominal exchange rates should reflect the inflation differences. This indicates that if nominal exchange rate changes reflect home and foreign inflation differences, then real exchange rate should remain unchanged. Recent time series econometrics techniques can test this proposal. If the real exchange rate series contain a unit root, then the series are told to be nonstationary which means that PPP (Purchasing power parity) does not hold. Augmented Dickey Fuller and Phillips-Perron unit root tests are used to test the stationarity of the real exchange rate series. The real exchange rate is defined in terms of both United States consumer prices and industrialized countries’ consumer prices. This study is conducted for the period 1986.1-1997.4 for 18 developing countries. The countries under consideration are Bolivia, Chile, Mexico, Ecuador, Uruguay, Costa Rica, Dominican Republic, Jamaica, Morocco, Ghana, Nigeria, India, Indonesia, S. Korea, Pakistan, Philippines, Sri Lanka, and Turkey. Unit root test results indicate that none of the real exchange rate series are stationary for these countries. Therefore, it can be claimed that PPP does not hold for these countries when PPP is defined in terms of real exchange rate.