PPP and the Euro-area

Kees C. G. Koedijk · Ben Tims · Mathijs A. van Dijk

98 citations0/0 files storedResearch Publications (Maastricht University)

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Monetary Policy and Economic Impact Global Financial Crisis and Policies Economic Growth and Productivity

Abstract

This paper analyzes purchasing power parity (PPP) for the euro area. We study the impact of the introduction of the euro in 1999 on the behavior of real exchange rates. We test the PPP hypothesis for a panel of real exchange rates within the euro area over the period 1973-2003. Our methodology exploits the cross-sectional dependence across real exchange rates and allows for heterogeneity in the rates of mean reversion. We present evidence in favor of PPP for the full panel of real exchange rates, but we show that accounting for cross-country differences within the euro area is essential. The unit root hypothesis can be rejected for some real exchange rates, but evidence for PPP is weak for others. We also investigate PPP between the “synthetic” euro against several other major currencies over the period 1979-2003. We find support for the PPP hypothesis for the full panel of real exchange rates. When the restriction of a common mean reversion coefficient is relaxed, we reject the unit root hypothesis for the euro-Swiss franc rate only. We conclude that the process of economic integration in Europe has accelerated convergence toward PPP within the euro area.

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References

1979Distribution of the Estimators for Autoregressive Time Series with a Unit Root 1979Distribution of the Estimators for Autoregressive Time Series With a Unit Root 1991Pitfalls and Opportunities: What Macroeconomists Should Know about Unit Roots 1998The overvaluation of purchasing power parity 1996Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries 1998The behavior of real exchange rates during the post-Bretton Woods period 1990Purchasing Power Parity in the Long Run 1994Perspectives on PPP and Long-Run Real Exchange Rates

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