Functional Forms and PPP: The Case of Canada, the EU, Japan, and the U.K.

This paper applies an extended Box-Cox model to test the functional form of the purchasing power parity hypothesis for Canada, the EU, Japan, and the U.K. Both the relative CPI and the relative PPI are considered in empirical work. The log-log form commonly chosen by most researchers can be rejected for Japan when the relative PPI is considered and the EU and the U.K. when the relative CPI or PPI is considered. The value of R2 is higher based on the relative PPI than that based on the relative CPI. None of the estimated elasticities is statistically equal to unity, suggesting that proportionality may not apply.