Document Type

Article

Journal/Book Title/Conference

Economics Research Institute Study Paper

Volume

9

Publisher

Utah State University Department of Economics

Publication Date

1997

Rights

Copyright for this work is held by the author. Transmission or reproduction of materials protected by copyright beyond that allowed by fair use requires the written permission of the copyright owners. Works not in the public domain cannot be commercially exploited without permission of the copyright owner. Responsibility for any use rests exclusively with the user. For more information contact the Institutional Repository Librarian at digitalcommons@usu.edu.

First Page

1

Last Page

21

Abstract

The literature on the purchasing power parity (PPP) theory reports that all versions of the PPP theory do badly in explaining exchange rate movements in terms of changes in national price levels. If purchasing power parity holds true, the real exchange rate remains constant over time. The negative empirical results point to the failure of PPP. This paper contends that if the equilibrium real exchange rate has shifted over time due to real shocks, then what is interpreted as the failure of the PPP may not actually be so. This paper investigates the issue and econometric tests indicate that the variable trend/cointegration implication is broadly consistent with the quarterly movements of bilateral exchange rates for the period 1973Ql to 1993Q4 between the U.S. and other countries like Germany, Japan, U.K., and Switzerland. One implication of this study is that it can serve as a benchmark for determining the limits of the band of target zone models.

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