Theory and Tests of Generalized Purchasing-Power Parity: Common Trends and Real Exchange Rates in the Pacific Rim.

The paper develops the theory of generalized purchasing-power parity (G-PPP) to explain the "stylized facts" of real exchange-rate behavior. The fundamental economic variables determining real exchange rates are nonstationary; thus real rates are nonstationary. If the fundamentals are sufficiently integrated, as in a currency area, the real rates will share common trends. The theory is tested using the Pacific Rim nations. It is shown the G-PPP holds between each of the Pacific Rim nations and the large industrialized countries. There is only mild evidence that G-PPP holds among the Pacific Rim nations as a group. Copyright 1994 by Blackwell Publishing Ltd.