parity reversion in real exchange rates during the post bretton woods period abstract a common view among recent studies on purchasing power parity is that the post bretton woods period is far too short to reveal any significant parity reversion in individual series of real exchange rates is this really so the answer this study shows depends very much on the statistical test being used two efficient univariate unit root tests are applied to uncover parity reversion these tests require much shorter sample sizes than conventional tests to attain the same statistical power empirical results show that parity reversion can be unveiled over the modern float if an efficient unit root test is applied

on identification of bayesian dsge models this article is concerned with local identification of individual parameters of dynamic stochastic general equilibrium dsge models estimated by bayesian methods identification is often judged by a comparison of the posterior distribution of a parameter with its prior however these can differ even when the parameter is not identified instead we propose two bayesian indicators of identification the first follows a suggestion by poirier of comparing the posterior density of the parameter of interest with the posterior expectation of its prior conditional on the remaining parameters the second examines the rate at which the posterior precision of the parameter gets updated with the sample size using data simulated at the parameter point of interest for an increasing sequence of sample sizes t for identified parameters the posterior precision increases at rate t for parameters that are either unidentified or are weakly identified the posterior precision may get updated but its rate of update wi

the social ecology of the post fordist global city economic restructuring and socio spatial polarisation in the toronto urban region numerous authors have asserted that globalisation and occupational changes associated with post fordist economic restructuring have led to a growth in intraurban social disparity and even polarisat

quantifying the uncertainty about the half life of deviations from ppp we propose a bayesian framework in which the uncertainty about the half life of deviations from purchasing power parity can be quantified based on the responses to a survey study we propose a prior probability distribution for the half life under the recent float intended to capture widely held views among economists we derive the posterior probability distribution of the half life under this consensus prior and confirm the presence of substantial uncertainty about the half life we provide for the first time a comprehensive formal evaluation of several nonnested hypotheses of economic interest including rogoff s 1996 claim that the half life is contained in the range of 3 to 5 years we find that no hypothesis receives strong support from the data copyright 2002 john wiley sons ltd

industrial shift skill mismatch and income inequality a decomposition analysis of changing distributions in the oslo region this paper examines changing income inequality in the oslo region between 1993 and 2000 adopting a decomposition approach the analysis reveals that both earnings inequality and post tax inequalit

factor models and time varying parameter framework for forecasting exchange rates and inflation a survey a survey of models used for forecasting exchange rates and inflation reveals that the factor based and time varying parameter or state space models generate superior forecasts relative to all other models this survey also finds that models based on taylor rule and portfolio balance theory have moderate predictive power for forecasting exchange rates the evidence on the use of bayesian model averaging approach in forecasting exchange rates reveals limited predictive power but strong support for forecasting inflation overall the evidence overwhelmingly points to the context of the forecasts relevance of the historical data data transformation choice of the benchmark selected time horizons sample period and forecast evaluation methods as the crucial elements in selecting forecasting models for exchange rate and inflation

monetary policy indeterminacy and identification failures in the u s results from a robust test we propose a novel identi cation robust test for the null hypothesis that an estimated new keynesian model has a reduced form consistent with the unique stable solution against the alternative of sunspot driven multiple equilibria our strategy is designed to handle identi cation failures as well as the misspeci cation of the relevant propagation mechanisms we invert a likelihood ratio test for the cross equation restrictions cer that the newkeynesian system places on its reduced form solution under determinacy if the cer are not rejected sunspot driven expectations can be ruled out from the model equilibrium and we accept the structural model otherwise we move to a second step and invert an anderson and rubin type test for the orthogonality restrictions or implied by the system of euler equations the hypothesis of indeterminacy is accepted if the or are not rejected we investigate the nite sample performance of the suggested two steps testing strategy by some monte carlo experiments we apply our robust test to a new keynesian ad as model estimated with actual u s post wwii data in spite of some evidence of weak identi cation

potential pitfalls for the purchasing power parity puzzle sampling and specification biases in mean reversion tests of the law of one price the ppp puzzle is based on empirical evidence that international price differences for individual goods loop or baskets of goods ppp appear highly persistent or even nonstationary the present consensus is these price differences have a half life that is of the order of five years at best and infinity at worst this seems unreasonable in a world where transportation and transaction costs appear so low as to encourage arbitrage and the convergence of price gaps over much shorter horizons typically days or weeks however current empirics rely on a particular choice of methodology involving i relatively low frequency monthly quarterly or annual data and ii a linear model specification in fact these methodological choices are not innocent and they can be shown to bias analysis towards findings of slow convergence and a random walk intuitively if we suspect that the actual adjustment horizon is of the order of days then monthly and annual data cannot be expected to reveal it if we suspect arbitrage costs are high enough to produce a substantial band of inaction then a linear model will fail to support convergence if the process spends considerable time random walking in that band thus when testing for ppp or loop model specification and data sampling should not proceed without consideration of the actual institutional context and logistical framework of markets

median unbiased estimation of structural change models an application to real exchange rate persistence measuring deviations from purchasing power parity has been the subject of extensive investigation the most common practice in empirical research for measuring real exchange rate persistence is to estimate univariate autoregressive ar time series models and calculate the half life defined as the number of periods for a unit shock to a time series to decay by 50 in the presence of structural change there are two potential biases in the parameter estimates of ar models 1 a downward small sample median bias and 2 an upward bias which occurs when structural change is present and ignored we conduct a variety of monte carlo simulations and demonstrate that the existence of structural change causes a substantial increase in the small sample bias documented in andrews 1993 we then propose an extension of median unbiased estimation which explicitly accounts for structural change and apply these methods to estimate half lives of several long horizon real exchange rates analysed by lothian and tayl

confidence intervals for half life deviations from purchasing power parity existing point estimates of half life deviations from purchasing power parity ppp around 3 5 years suggest that the speed of convergence is extremely slow this article assesses the degree of uncertainty around these point estimates by using local to unity asymptotic theory to construct confidence intervals that are robust to high persistence in small samples the empirical evidence suggests that the lower bound of the confidence interval is between four and eight quarters for most currencies which is not inconsistent with traditional price stickiness explanations however the upper bounds are infinity for all currencies so we cannot provide conclusive evidence in favor of ppp either

social polarisation in global cities theory and evidence this paper examines the debate over social polarisation in global cities it focuses on the claims made by sassen that the processes of economic change in such cities are leading to a growing polar

the purchasing power parity persistence paradigm abstract rogoff journal of economic literature 1996 34 647 668 describes the remarkable consensus of 3 5 year half lives of purchasing power parity deviations among studies using long horizon data these studies however focus on rejections of unit roots in real exchange rates and do not use appropriate techniques to measure persistence our half life estimates explicitly account for serial correlation sampling uncertainty and most importantly small sample bias calculating confidence intervals as well as point estimates for long horizon and post 1973 data we find that even though most of the point estimates lie within the 3 5 year range univariate methods provide virtually no information regarding the size of the half lives

evaluating the information matrix in linearized dsge models abstract in this note we show how the stochastic general equilibrium dsge models can be evaluated analytically the result is useful for the estimation and identification analysis of such models

how puzzling is the ppp puzzle an alternative half life measure of convergence to ppp summary evidence of lengthy half lives for real exchange rates in the presence of a high degree of exchange rate volatility has been considered as one of the most puzzling empirical regularities in international macroeconomics this paper suggests that the measure of half life used in the literature might be problematic and proposes alternative measures with desirable properties their focus on the cumulative effects of the shocks distinguishes them from the measures used in the literature an empirical analysis of bilateral us dollar real exchange rates employing the alternative half life measure produces results consistent with theory and indicates that the ppp puzzle is less pronounced than initially thought copyright 2012 john wiley sons ltd

median unbiased estimation in df gls regressions and the ppp puzzle using median unbiased estimation recent research has questioned the validity of rogoff s remarkable consensus of 3 5 year half lives of deviations from ppp these half life estimates however are based on estimates from regressions where the resulting unit root test has low power we extend median unbiased estimation to the df gls regression of elliott rothenberg and stock 1996 we find that median unbiased estimation based on this regression has the potential to tighten confidence intervals for half lives using long horizon real exchange rate data we find that the typical lower bound of the confidence intervals for median unbiased half lives is just under 3 years thus while previous confidence intervals for half lives are consistent with virtually anything our tighter confidence intervals now rule out economic models with nominal rigidities as candidates for explaining the observed behavior of real exchange rates therefore while we obtain more information using efficient unit root tests on longer term data this information moves us away from solving the ppp puzzle

was it real the exchange rate interest differential relation over the modern floating rate period in this paper we explore the relationship between real exchange rates and real interest rate differentials in the united states germany japan and the united kingdom contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant we find little evidence of a stable relationship between real interest rates and real exchange rates we consider both in sample and out of sample tests one hypothesis that is consistent with our findings is that real disturbances such as productivity shocks may be a major source of exchange rate volatility this paper investigates the empirical relationship between major currency real exchange rates and real interest rates over the modern post march 1973 flexible rate experience the exchange rates examined here include the dollar mark dollar yen and dollar pound rates our two major findings are as follows first the data do not indicate a strong correspondence between real interest rate differentials short term or long term and real exchange rates this finding appears to conflict with the predictions of most monetary and portfolio balance models of exchange rate determination though the conflict can be substantially reconciled if aggregate disturbances are primarily real in nature i e changes in productivity tastes etc it is true that in many cases the sign of the estimated exchange rate interest rate differential relationship is consistent with the possible predominance of financial market disturbances but the relationship is not stable enough to be statistically significant second although one does find some evidence of a unit root in both real exchange rates and long term but not shortterm real interest differentials these two series do not appear to be linearly cointegrated hence the nonstationarity or near nonstationarity in the two series cannot be attributed to the same factor in section i we briefly describe a class of small scale monetary models of exchange rate determination the importance of this class of models for empirical work derives from its strong predictions about how the exchange rate will move

real exchange rate behavior the recent float from the perspective of the past two centuries using annual data spanning two centuries for dollar sterling and franc sterling real exchange rates we find strong evidence of mean reverting real exchange rate behavior using simple stationary autoregressive models estimated on prefloat data we easily outperform nonstationary real exchange rate models in dynamic forecasting exercises over the recent float such stationary univariate equations explain 60 80 percent of the in sample variation in real exchange rates although the degree of short run persistence may be high the econometric estimates imply a half life of shocks to the real exchange rate of about 6 years for dollar sterling and a little under 3 years for franc sterling

a tale of fat tails abstract we document the extent to which major macroeconomic series used to inform linear dsge models can be characterized by power laws whose indices we estimate via maximum likelihood assuming data follow a linear recursion with multiplicative noise low estimated indices suggest fat tails we then ask whether standard dsge models under constant gain learning can replicate those fat tails by an appropriate increase in the estimated gain and without much change in the transmission mechanism of shocks we find that is largely the case via implementation of a minimum distance estimation method that eschews any allegiance to distributional assumptions

social polarisation economic restructuring and welfare state regimes the central argument of this paper is that it is misconceived to view social polarisation of occupational structure and incomes in global cities as either inevitable or as a direct product of econo

post industrialisation job opportunities and ethnocentrism a comparison of twenty two dutch urban economies this article assesses the consequences of the transition to a post industrial urban economy for labour demand and ethnocentrism in the 22 dutch urban agglomerations using municipal level data as well as surveys it is shown that the labour market of the least post industrial cities yields low labour demand for lower educated urbanites upgrading professionalisation thesis while the labour market of the most post industrial cities yields high labour demand for lower educated urbanites polarisation thesis it is furthermore found that lower educated natives in the former are more ethnocentric than in the latter however contrary to what is often claimed in urban studies and the social sciences at large this proves not to be driven by job scarcity in the least post industrial cities the article concludes with suggestions on what might be responsible for this finding

the link between life insurance activities and economic growth some new evidence abstract this paper applies the panel seemingly unrelated regressions augmented dickey fuller suradf test to re investigate the stationarity properties of real life insurance premiums per capita and real gross domestic product gdp per capita for 41 countries within three levels of income covering 1979 2007 our empirical results first reveal that the variables in these countries are a mixture of i 0 and i 1 processes and that the traditional panel unit root tests could lead to misleading inferences second for the estimated half lives the degrees of mean reversion are greater in high income countries third there is concrete evidence favoring the hypothesis of a long run equilibrium relationship between real gdp and real life insurance premiums after allowing for the heterogeneous country effect the long run estimated panel parameter results indicate that a 1 increase in the real life premium raises real gdp by 0 06 finally we determine that the development of life insurance markets and economic growth exhibit long run and short run bidirectional causalities these findings offer several useful insights for policy makers and researchers

frequentist evaluation of small dsge models this article proposes a new evaluation approach for the class of small scale hybrid new keynesian dynamic stochastic general equilibrium nk dsge models typically used in monetary policy and business cycle analysis the empirical assessment of the nk dsge model is based on a conditional sequence of likelihood based tests conducted in a vector autoregressive var system in which both the low and high frequency implications of the model are addressed in a coherent framework if the low frequency behavior of the original time series of the model can be approximated by nonstationary processes stationarity must be imposed by removing the stochastic trends this gives rise to a set of recoverable unit roots cointegration restrictions in addition to the short run cross equation restrictions the procedure is based on the sequence lr1 lr2 lr3 where lr1 is the cointegration rank test lr2 is the cointegration matrix test and lr3 is the cross equation restrictions test lr2 is computed conditional on lr

exchange rate predictability the main goal of this article is to provide an answer to the question does anything forecast exchange rates and if so which variables it is well known that exchange rate fluctuations are very difficult to predict using economic models and that a random walk forecasts exchange rates better than any economic model the meese and rogoff puzzle however the recent literature has identified a series of fundamentals methodologies that claim to have resolved the puzzle this article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up to date thorough empirical analysis overall our analysis of the literature and the data suggests that the answer to the question are exchange rates predictable is it depends on the choice of predictor forecast horizon sample period model and forecast evaluation method predictability is most apparent when one or more of the following hold the predictors are taylor rule or net foreign assets the model is linear and a small number of parameters are estimated the toughest benchmark is the random walk without drift

foreign direct investment and international migration to dutch cities this article assesses separately the push pull factor explanations in sassen s theory on migration from newly industrialising countries to cities in oecd countries the push factor explanation argues that foreign direct investments spawn migration flows to the country from which these investments stem the pull factor explanation revolves around demand for low skilled workers in cities due to the clustering of advanced producer services it is found that dutch investment flows indeed function as a push factor for migration to dutch cities but that the local settlement of immigrants is not related to the clustering of advanced producer services

size distortions of tests of the null hypothesis of stationarity evidence and implications for the ppp debate abstract tests of the null hypothesis of stationarity against the unit root alternative play an increasingly important role in empirical work in macroeconomics and in international finance we show that the use of conventional asymptotic critical values for stationarity tests may cause extreme size distortions if the model under the null hypothesis is highly persistent this fact calls into question the use of these tests in empirical work we illustrate the practical importance of this point for tests of long run purchasing power parity ppp under the recent float we show that the common practice of viewing tests of stationarity as complementary to tests of the unit root null will tend to result in contradictions and in spurious rejections of long run ppp while the size distortions may be overcome by the use of finite sample critical values the resulting tests tend to have low power under economically plausible assumptions about the half life of deviations from ppp thus the fact that stationarity is not rejected cannot be interpreted as convincing evidence in favor of mean reversion only in the rare case that stationarity is rejected do size corrected tests shed light on the question of long run ppp

post industrialization job opportunities and ethnocentrism in this article we assess the consequences of the transition to post industrial urban economy for labour demand and ethnocentrism in the 22 dutch urban agglomerations using municipal level data as well as surveys we show that the labour market of the least post industrial cities yields low labour demand for lower educated urbanites upgrading professionalisation thesis while the labour market of the most post industrial cities yields high labour demand for lower educated urbanites polarisation thesis it is furthermore found that lower educated natives in the former are more ethnocentric than in the latter however contrary to what is often claimed in urban studies and the social sciences at large this proves not to be driven by job scarcity in the least post industrial cities the article concludes with suggestions on what might be responsible for this finding

cultural amenities and unemployment in dutch cities disentangling a consumerist and productivist explanation for less educated urbanites varying unemployment levels across urban economies previous studies on the advanced economies have shown that unemployment levels of the less educated are low in cities with high employment shares in the advanced producer services scholars have consistently interpreted this finding according to sassen s polarisation thesis this article confronts this production based interpretation with a competing consumption based explanation which focuses on the role of cultural amenities analysing data on 22 dutch metropolitan agglomerations between 1996 and 2008 it is shown that in line with consumerists notions of richard florida advanced producer services settle in cities that are rich in cultural amenities instead of the other way around as classical labour follows capital explanations imply yet only advanced producer services prove to reduce the unemployment levels of the less educated meaning that the polarisation thesis and not the theory on cultural amenities is a valid explanation for the low level of unemployment in post industrial cities

explaining deindustrialization globalization failure or success although sociologists have expressed growing interest in globalization they have devoted little sustained empirical attention to the many claims made in its name i focus on the link that has been drawn between globalization and the deindustrialization of the advanced industrial societies to examine this i employ a pooled time series of cross sections data set that combines observations on 18 oecd nations across the 1968 1992 period fixed effects regression models that control for unmeasured country specific effects reveal support for arguments that implicate foreign direct investment and north south trade in the declining percentage of the labor force employed in manufacturing in the oecd countries regression results also show that deindustrialization across this period is largely explained by a model that combines an attention to the post golden age troubles of northern manufacturing with classic generalizations of the process of development interpretation of the empirical findings is tempered by an exercise in counterfactual history which reveals that deindustrialization would have been considerable in these countries even if the upswings in direct investment and southern imports had not occurred or if the performance of the manufacturing sector had been stronger

do panels help solve the purchasing power parity puzzle although rogoff described the remarkable consensus of 3 to 5 year half lives of purchasing power parity ppp deviations among studies using long horizon data recent works using panel methods with post 1973 data report shorter half lives of 2 to 2 5 years but these studies do not use appropriate techniques to measure persistence we extend median unbiased estimation methods to the panel context calculate both point estimates and confidence intervals and provide strong evidence confirming rogoff s original claim although panel regressions provide more information on the persistence of real exchange rate shocks than univariate regressions they do not help solve the ppp puzzle

unravelling the global city debate on social inequality a firm level analysis of wage inequality in amsterdam and rotterdam in this article an assessment is made of the consequences of globalisation for urban wage inequality using data on employers in the dutch cities of amsterdam and rotterdam it is shown that simpl

a panel project on purchasing power parity mean reversion within and between countries abstract previous time series studies have shown evidence of mean reversion in real exchange rates deviations from purchasing power parity ppp appear to have half lives of approximately four years however the long samples required for statistical significance are unavailable for most currencies and are potentially inappropriate because of regime changes in this study we re examine deviations from ppp using a panel of 150 countries and 45 annual post wwii observations our panel shows strong evidence of mean reversion that is similar to that from long time series ppp deviations are eroded at a rate of approximately 15 annually i e their half life is around four years such findings can be masked in time series data but are relatively easy to find in cross sections

market frictions and real exchange rates abstract one explanation for the failure of purchasing power parity ppp is that market frictions impede trade allowing departures from ppp to grow quite large without precipitating goods arbitrage if this explanation is correct then other things equal large deviations from ppp should be less persistent than small differences this paper examines this prediction over the modern floating rate era the outcome is surprising between most countries large deviations from ppp appear to be at least as persistent as small deviations and perhaps even more so the exceptions are for some intra ec real exchange rates the implication is that market frictions alone do not explain the chimerical nature of ppp

the evolution of purchasing power parity abstract a large body of literature in international finance has attempted to estimate the speed of convergence between countries aggregate price indices to those levels predicted by purchasing power parity ppp this paper takes a novel approach by considering how this speed of convergence itself has evolved over time using a dynamic common correlated effects dcce framework from chudik and pesaran 2015 applied to a panel of countries real exchange rates over the years 1960 2015 we find an average half life of around 3 years moreover we show that the estimated half life fell by about 2 years over the course of the past five decades suggesting that the so called ppp puzzle rogoff 1996 may abating over time our results also serve to contextualize past estimates by demonstrating a high degree of sample selection sensitivity in this literature furthermore we propose explanations for the observed increase in the speed of international price adjustments focusing primarily on the increasingly tradable nature of the composition of the u s consumer price index cpi we build a measure of tradability of the cpi and show that despite an increase in the proportion of services in the average consumer s basket the cpi has become more tradable over time thus offering a potential explanation for the observed increase in adjustment speed

post industrialisation immigration and unemployment how and why the impact of immigration on unemployment differs between dutch cities studies on the substitution thesis in advanced economies show scattered results the impact of immigration on the wages and likelihood of unemployment of the less educated varies strongly both studies on the substitution thesis itself and studies on the unequal post industrial development of urban economies suggest that this is because the substitution thesis is conditional on the type of urban economy the empirical validity of this suggestion is tested by comparing the impact of immigration on the employment level of the less educated among 22 dutch metropolitan areas the findings corroborate the central hypothesis in strong service oriented urban economies the impact of immigration on unemployment levels is mitigated because of high labour demand for the less educated

explaining deindustrialization how affluence productivity growth and globalization diminish manufacturing employment1 this study analyzes why the world s most economically advanced countries have deindustrialized over the last few decades previous research focuses on three causal factors 1 rising consumer affluence and its propensity to increase demand for services more than for manufactured goods 2 faster productivity growth in the manufacturing sector relative to other sectors and 3 expanding trade linkages between the north and the south of the global economy the relative importance of these factors however is not fully understood because previous research has not tested all of these explanations simultaneously nor considered the indirect channels through which global trade may cause deindustrialization this study tests the three factors with two way fixed effects regression models and panel data on 18 oecd countries from 1970 to 2003 the results indicate that each factor makes significant contributions to deindustrialization and that global trade exerts both direct and indirect effects on employment

local identification in dsge models abstract the issue of identification arises whenever structural models are estimated lack of identification means that the empirical implications of some model parameters are either undetectable or indistinguishable from the implications of other parameters therefore identifiability must be verified prior to estimation this paper provides a simple method for conducting local identification analysis in linearized dsge models estimated in both full and limited information settings in addition to establishing which parameters are locally identified and which are not researchers can determine whether the identification failures are due to data limitations such as lack of observations for some variables or whether they are intrinsic to the structure of the model the methodology is illustrated using a medium scale dsge model

identification of dsge models the effect of higher order approximation and pruning abstract this paper shows how to check rank criteria for a local identification of nonlinear dsge models given higher order approximations and pruning this approach imposes additional restrictions on higher order moments and polyspectra which can be used to identify parameters that are unidentified in a first order approximation the identification procedures are demonstrated by means of the kim 2003 and the an and schorfheide 2007 models both models are identifiable with a second order approximation furthermore analytical derivatives of unconditional moments cumulants and corresponding polyspectra up to fourth order are derived for the pruned state space

purchasing power parity under the gold standard 1 introduction long run purchasing power parity lrppp a mainstay of international economic theory has proved difficult to back up empirically many attempts have been made using various time series of data yet results continue to be mixed a standout exception to these mixed results is presented by diebold husted and rush 1991 whose work has been interpreted as very strong evidence of lrppp because of their across the board rejection of the unit root for a large sample of real exchange rates baillie 1996 p 51 cites diebold husted and rush as reestablishing purchasing power parity as a meaningful long run concept despite the substantial mixed results of other studies these mixed results are usually attributed to the power problems associated with standard unit root tests especially for small samples diebold husted and rush 1991 overcome these shortcomings by loosening the structure of the model to allow a longmemory process diebold husted and rush 1991 model real exchange rate behavior using autoregressive fractionally integrated moving average arfima models in doing so they reject the unit root for 16 real exchange rates from the gold standard era in favor of a fractionally integrated alternative hypothesis a long memory process is essentially a stationary one but where the autocorrelations take far longer to decay than the exponential rate associated with the autoregressive moving average arma class baillie 1996 p 6 this observation implies that purchasing power parity ppp holds but in some cases only in the extreme long run we agree with diebold husted and rush 1991 that the structure of standard unit root tests is overly restrictive however we offer a different solution to this problem from standard unit root tests one must conclude that either all deviations from ppp are permanent or all deviations dissipate over time however there is a third possibility that has both theoretical and empirical support unit root tests do not allow the possibility that while most deviations dissipate a few remain as permanent shocks real exchange rates may show substantial mean reversion but to a changing mean rather than to the constant ppp value this idea which we call quasi purchasing power parity qppp draws support from the balassasamuelson theory which asserts that productivity shocks can have permanent effects on real exchange rates samuelson 1994 p 202 criticizes economists who tried to use ppp as a guide even when substantive microeconomic changes had taken place between the previous putative equilibrium period and the new status quo he cites an example from the 1980s when the actual yen dollar exchange rate was 150 yen per dollar according to ppp the equilibrium exchange rate was 200 yen per dollar yet the rate proceeded to drop to 110 yen per dollar and below in qppp terms this situation would represent not a lack of mean reversion but evidence of an equilibrium that had shifted away from ppp this is a form of the penn effect whereby a rich country in comparison with a poor one will be estimated to be richer than it really is if you pretend that the simplified cassel version of purchasing power parity is correct samuelson 1994 p 201 we assert that this penn effect can occur not just between rich and poor countries but between any two countries if one of these countries is affected by a permanent external shock qppp also supports engel s 1996 p 1 proposition that the real exchange rate evolves as the sum of two processes a stationary but persistent component and a non stationary component it is generally held that while the exchange rate deviates from its long run equilibrium value in the short run it eventually converges to that equilibrium value in the long run the question then is what is that long run equilibrium value some argue it is the ppp level while others argue that there is a complex set of factors determining the long run value including such things as the relative labor productivities at home and abroad engel 1996 p

transactions costs and nonlinear adjustment in real exchange rates an empirical investigation eolquilibrium models of real exchange rate determination in the presence of transactions costs imply a nonlinear adjustment process toward purchasing power parity ppp conventional cointegration tests which ignore the effect of transactions costs may be biased against the long run ppp hypothesis our results using both monthly data for the interwar period and annual data spanning two centuries clearly reject the linear framework in favor of an exponential smooth transition autoregressive process the systematic pattern in the estimates of the nonlinear models provides strong evidence of mean reverting behavior for ppp deviations and helps explain the mixed results of previous studies

smooth structural breaks and the stationarity of the yen real exchange rates this article examines and solves an interesting paradox in the literature that the tests for purchasing power parity ppp based on the yen real exchange rates rers refute the ppp hypothesis more often than those with other major currency based rers and the evidence is sensitive to the sample period used using a new empirical methodology accounting for both nonlinearity and multiple smooth temporary breaks in the data we show that the puzzling finding is due to the failure to take into account the long but temporary large rise and fall in the yen rers the results illustrate that the yen rers in the post bretton woods period are likely mean reverting with linear or nonlinear adjustment toward large long swing type of infrequent smooth temporary changes around constant equilibrium values supporting the validity of ppp and resolving the paradox

additional evidence of long run purchasing power parity with restricted structural change we investigate two alternative versions of purchasing power parity ppp reversion to a constant mean in the spirit of cassel and reversion to a constant trend in the spirit of balassa and samuelson using long span real exchange rate data for industrialized countries we develop unit root tests that both account for structural change and maintain a long run mean or trend with conventional tests previous research finds evidence of some variant of ppp for 9 of the 16 countries with the unit root tests in the presence of restricted structural change we find evidence of ppp for five additional countries

the overvaluation of purchasing power parity abstract recent panel studies of purchasing power parity have reported strong evidence of mean reversion in real exchange rates however these studies fail to control for cross sectional dependence in the data this failure has dramatic consequences raising the significance level of tests with a nominal size of 5 percent to as much as 50 percent it is shown in this paper that controlling for cross sectional dependence no evidence against the random walk null can be found in panels of up to 64 real exchange rates this finding cannot be attributed to low power as there is ample power in panels of this size to reject the unit root null