Long-Run and Short-Run Dynamics of the Exchange Rate in Pakistan: Evidence from Unrestricted Purchasing Power Parity Theory
The Lahore Journal of Economics 13 : 1 (Summer 2008): pp. 29-56
29 Pages Posted: 5 Dec 2017
Date Written: 2008
The main focus of this paper is to measure the speed of adjustment of the exchange rate by means of the persistent profile approach developed by Pesaran and Shin (1996) to examine the symmetry and proportionality assumptions of the purchasing power parity (PPP) theory of exchange rates for the Pak-rupee vis-à-vis the US-dollar exchange rate over the period 1982Q2-2005Q4. Using cointegration and vector error-correction modeling approaches, we find considerable support for the validity of weak-form PPP in Pakistan. Furthermore, the symmetry and proportionality assumptions of PPP are not verified. In the short-run, the exchange rate and foreign prices play a significant role in the convergence process to achieve long-run equilibrium. However, the speed of adjustment is very slow and the persistence profiles suggest that almost 4-5 years are required to eliminate deviations and bring the nominal exchange rate in line with the long-run equilibrium path.
Keywords: Exchange Rate, Purchasing Power Parity, Cointegration, Vector Error Correction, Pakistan
JEL Classification: C13, C22, C51, F31, F37
Suggested Citation: Suggested Citation