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Purchasing Power Parity: Error Correction Models and Structural Breaks

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Abstract

This paper examines purchasing power parity (PPP) behavior using error correction models (ECM) and allowing for structural breaks. We distinguish four different objectives: first, this paper examines which variable or variables (the exchange rate and/or international relative prices) exhibit a significant error correction mechanism. Second, this paper presents empirical evidence about the adjustment velocity to the long-run equilibrium. Third, it examines the evidence regarding cointegration and the adjustment coefficients parameter instability, and finally, it analyzes whether traded and non-traded sectors exhibit different behavior. The most important results are: (1) the predominant adjustment is in the exchange rate with a larger velocity adjustment than in relative prices; (2) the evidence suggests that when there are strong depreciations or appreciations in the exchange rate, the international relative prices adjust (i.e., there is evidence of pass-through); (3) the dynamic adjustment to equilibrium is, in general, stable.

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Authors and Affiliations

  1. Departamento de Teoría Económica, Facultad de Ciencias Económicas y Empresariales, Universidad de Málaga, Campus de El Ejido, s/n, 29013, Málaga, Spain. amalia@uma.es

    Amalia Morales Zumaquero

  2. Departamento de Economía Cuantitativa, Universidad Complutense de Madrid, Spain

    Rodrigo Peruga Urrea

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  1. Amalia Morales Zumaquero
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  2. Rodrigo Peruga Urrea
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Zumaquero, A.M., Urrea, R.P. Purchasing Power Parity: Error Correction Models and Structural Breaks. Open Economies Review 13, 5–26 (2002). https://doi.org/10.1023/A:1012298028415

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