Does the PPP Need the Uip?
IGIER Working Paper No. 97
Posted: 4 Nov 1996
Date Written: February 1996
Abstract
In this paper we focus on the post Bretton Woods period and analyze whether a PPP relationship is accepted by the data for Italy, United States and Germany. We adopt a multivariate system approach in which, initially, we test for cointegration and then we try to identify a cointegration space where the PPP holds (the 'Johansen approach'). The studies that have adopted this approach have always rejected the PPP in favour of a long-run relationship between the real exchange rate and the interest rate differential. On the contrary, our conclusions are in favour of the PPP for all the cases considered when we allow for a structural break in the data. We arrive to this conclusion after having identified the cointegration space in two different ways: one in which we have the PPP as a cointegrated vector, and one in which the real exchange rate plus the interest rate differential is a cointegrated vector. Adopting a dominance criterion we choose the former identification.
JEL Classification: E4, F31
Suggested Citation: Suggested Citation