PURCHASING POWER PARITY, PRODUCTIVITY DIFFERENTIALS AND NON-LINEARITY

The purpose of this paper is to apply a symmetric band threshold autoregressive model to investigate the non-linear adjustment of the real pound-dollar rate over a period from 1885 to 2003. After controlling for the Harrod-Balassa-Samuelson effects, we find evidence to support a non-linear mean reversion of the real pound-dollar rate. Moreover, the estimated half-life is about two years with large shocks. We therefore provide a solution to the purchasing power parity puzzle. Copyright © 2009 The Authors. Journal compilation © 2009 Blackwell Publishing Ltd and The University of Manchester.