In this paper, we study the parity reversion of 40 main bilateral real exchange rates (RERs) constructed by actual price levels to be consistent with absolute purchasing power parity (PPP), rather than by price indexes as used in popular studies. The time series ADF and KPSS unit root tests reveal that 39 RERs are stationary in their periods of about 60 years or less. The half-lives span from 1 to 40 years and are mostly outside of the consensus range of 3-5 years in relative PPP. Thus, the parity reversion of absolute PPP may be very different from that of relative PPP.
Abstract. In popular studies, the theory of relative purchasing power parity (PPP) is tested for the real exchange rates (RERs) that are constructed by price indexes. In this paper, we construct the bilateral RERs by general price levels and study the absolute PPP theory in G7 countries. Coefficient restriction and RER misalignment distribution tests reveal that absolute PPP holds for the RERs of Canada, France, Germany, and Japan against the US in the whole samples. For the RERs of Italy and the UK against the US, we find the Balassa-Samuelson effect's modification to the absolute PPP theory in the sub-samples.
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