Purchasing Power Parity in the Transition: The Case of the Romanian Leu Against the Dollar

Abstract

This article uses co-integration analysis to test purchasing power parity for the Romanian leu against the US dollar. The fact that the purchasing power parity (PPP) hypothesis is not rejected leads to the conclusion that the real appreciation of the leu against the dollar over the transition has not been due to an appreciation of the equilibrium real exchange rate. Rather it is simply the consequence of the leu being devalued beyond the equilibrium level at the start of reform and slowly returning to its constant equilibrium real rate. There is evidence that the adjustment to equilibrium has fallen almost entirely on the price level, so that a major consequence of the excessive undervaluation has been higher inflation.

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