An empirical test of Purchasing Power Parity in the post-Bretton Woods era: a panel data approach

After the collapse of Bretton-Woods system, it was believed that under flexible exchange rate system nominal exchange rate will adjust instantaneously to reflect movements in prices between two countries. Consequently, Purchasing Power Parity (PPP) will hold continuously. This study examines the validity of long-run PPP hypothesis for two panels of OECD and developing Asian countries. The results of the study suggest that the PPP hypothesis with its strict symmetry and proportionality condition does not hold in the post-Bretton Woods era. However, when the strict PPP conditions are relaxed, we find a cointegrating relationship between nominal exchange rate and prices, which in turn provides support for the weak form of PPP.