A cointegration test of purchasing power parity: Some international evidence.

This study investigates the existence of long run Purchasing Power Parity (PPP) for the G7 countries (the United States, Canada, Germany, United Kingdom, France, Italy and Japan). Using the unit root test as well as cointegration techniques we have tested the PPP doctrine. The empirical results indicate that both effective exchange rate and consumer price index time series are nonstationary. Furthermore, the relationship between the effective exchange rate and the price level is shown to be in long run equilibrium in the United States, Canada, Japan and Italy but no evidence for PPP can be found for Germany, the United Kingdom and France. Thus, it can be claimed that the United States, Canada and Japan's markets allow the exchange rate to fluctuate freely as opposed to the European markets, since European economies are prone to disturbances (real shocks) that lead to permanent deviations from the PPP.