Empirical Analysis on Stability of Real Effective Exchange Rate Based on PPP Theory

Abstract

Purchasing power parity (PPP) has been one of the most enduring concepts in the global economy. However, its validity has been questioned around for a long time. In this study, annual data on real effective exchange rates for 64 countries or regions from 1994−2022 are used to conduct a unit root test without structural breaks, followed by the same test containing one or two structural breaks. The result shows that a unit root test with structural break leads to an increase in the number of countries with a steady state of the exchange rate, as this method reflects the effect of irresistible factors on smoothness. In general, 43 countries or regions have a steady series of the real effective exchange rate, which means that 67.19% of them follow mean reversion, confirming the validity of the PPP theory. Developed countries (regions) and emerging countries (regions) are steady overall, and the opposite is true for frontier countries (regions).