Abstract
This paper presents indirect evidence that absolute purchasing power parity (PPP) may hold in the long-run between Mexico and the U.S., but due to data limitations, the relationship could not be tested directly. Thus it is not clear if absolute PPP holds in the long run between the U.S. and Mexico. Given that relative PPP is a necessary, but not sufficient, condition for absolute PPP to hold, this study tests the relationship between the change in the log of the exchange rate, and the changes in the log of the U.S. producer price index (PPI) and the Mexican PPI. Here, the absence of relative PPP would indicate that absolute PPP could not hold. Given that all the relevant variables in first difference log are stationary, PPP in its relative form holds and OLS can be applied directly in a VAR model setting, viz., treating all variables initially as potentially endogenous. The estimates indicate one-way Granger causality from the percentage change in the exchange rate to the percentage change in the Mexican price level, which is not an implausible result for an emerging nation such as Mexico which imports a significant fraction of (dollar denominated) intermediate products and capital inputs.
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Notes
Using a VECM to initially test for this restriction is a relatively new approach in PPP. Previous literature may not have had access to more modern cointegration techniques or may have just assumed the restriction held so that the model could be written in terms of just two variables, the exchange rate and price ratio. For examples of the assumption of this restriction, see Chen (1995) and Ramirez and Khan (1999).
The ZA test was conducted using Model C and four lags since the data are quarterly. All tests were conducted at the 5 % significance level. Full tests and results (i.e. constant, trend, etc.) are available upon request.
VECM results with two baseline cointegrating vectors are available upon request.
VECM results with one baseline cointegrating vector are available upon request.
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Yee, S., Ramirez, M.D. Purchasing Power Parity: A Time Series Analysis of the U.S. and Mexico, 1995–2007. Int Adv Econ Res 22, 409–419 (2016). https://doi.org/10.1007/s11294-016-9598-4
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DOI: https://doi.org/10.1007/s11294-016-9598-4
Keywords
- Absolute PPP
- Granger block causality test
- Johansen cointegration test
- KPSS unit root test
- Mexico
- Pantula Principle
- Relative PPP
- Vector autoregressive model (VAR)
- Zivot-Andrews single-break unit root