Purchasing Power Parity in High-Inflation Countries: A Cointegration Analysis of Integrated Variables with Trend Breaks

Abstract

This paper examines the long‐run validity of purchasing power parity (PPP) for four high‐inflation countries. The method of Zivot and Andrews (1992) is employed to detect the time‐series behavior of the exchange rates and consumer price indices of these countries. We find that these variables are integrated with some trend breaks. We then utilize these data to test PPP using Johansen's (1988) multivariate cointegration technique. The cointegration tests are conducted with the correction of the finite sample bias and the adjustment for trend breaks. The results are consistent with the argument that, during the recent floating exchange‐rate period, PPP holds well, at least in a weak form, in high‐inflation countries where the general price level movement overshadows the factors causing deviations from PPP.

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