Long‐Run Purchasing Power Parity with Asymmetric Adjustment

Abstract

Tests of purchasing power parity (PPP) that use panel data are more supportive of the theory than are bilateral tests. The article uses threshold cointegration to explore long‐run PPP. Using data from the post‐Bretton Woods period, we show that cointegration with threshold adjustment holds for a number of European countries on a bilateral basis. Focusing on France and Germany as base countries, we show that the error‐correction model has important nonlinear characteristics in that prices and the exchange rate have markedly different adjustment patterns for positive gaps from PPP than negative gaps.

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