Adjusting Toward Long-Run Purchasing Power Parity

The logic of purchasing power parity (PPP) is compelling, but its evidence is mixed. This paper revisits PPP in 16 developed economies relative to the U.S. over 148 years (1870-2017). We use the ‘system pooled mean group’ (SPMG) model that allows two-way long-run causality between exchange rates and relative prices. This study detects consensus for PPP. We find evidence of PPP in 15/16 countries at a 10% significance level. The evidence of adjusting toward PPP is more common from relative prices than exchange rates. The exchange rates, however, adjust faster to the arbitrage condition