Purchasing Power Parity between the UK and the Euro Area

Open Economies Review, September 2014

53 Pages Posted: 1 Feb 2013 Last revised: 18 Mar 2015

See all articles by Giorgio Canarella

Giorgio Canarella

California State University, Los Angeles - Department of Economics & Statistics; University of Nevada, Las Vegas

Stephen M. Miller

University of Nevada, Las Vegas - Department of Economics; University of Connecticut - Department of Economics

Stephen K. Pollard

TUI University

Date Written: January 31, 2013

Abstract

We use the Johansen cointegration approach to assess the empirical validity of the purchasing power parity (PPP) between the UK and the Euro Area, which we represent by Germany, the largest of its members. We conduct the empirical analysis in the context of the global financial crisis that began in 2007 and find that it directly affects the cointegration space. We fail to validate the Johansen and Juselius (1992) original hypothesis that nonstationarity of the PPP associates with the nonstationarity of interest rate differentials to produce a stationary relation. On the other hand, we do not reject PPP. We find that PPP cointegrates with inflation differentials. We also find, contrary to conventional wisdom, that (i) equilibrium adjustment occurs between the German and UK inflation rates, while weak exogeneity exists for the German and UK interest rates and the PPP condition, and (ii) three common trends associated with the German interest rate, the UK interest rate, and the PPP condition “push” the system with the German interest rate and the PPP condition playing dominant roles.

Keywords: Purchasing Power Parity, Euro Area, Cointegrated VAR

JEL Classification: E31, E43, F31, F32

Suggested Citation

Canarella, Giorgio and Miller, Stephen M. and Pollard, Stephen K., Purchasing Power Parity between the UK and the Euro Area (January 31, 2013). Open Economies Review, September 2014. Available at SSRN: https://ssrn.com/abstract=2209991 or http://dx.doi.org/10.2139/ssrn.2209991

Giorgio Canarella

California State University, Los Angeles - Department of Economics & Statistics ( email )

Los Angeles
Los Angeles, CA 90032
United States

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

Stephen M. Miller (Contact Author)

University of Nevada, Las Vegas - Department of Economics ( email )

4505 S. Maryland Parkway
Box 456005
Las Vegas, NV 89154
United States
702-895-3776 (Phone)
702-895-1354 (Fax)

HOME PAGE: http://faculty.unlv.edu/smiller/

University of Connecticut - Department of Economics

365 Fairfield Way, U-1063
Storrs, CT 06269-1063
United States

Stephen K. Pollard

TUI University ( email )

5665 Plaza Dr., 3rd Floor
CA, 90630
Cypress, CA 90630
United States

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