PPP Over a Century: Cointegration and Structural Change

Abstract

The purpose of this paper is to investigate the ability of parameter instability tests in regressions with I(1) processes to discriminate between changes in the cointegrating relationship and changes in the marginal distribution of the regressors. Using annual data for the G-7 countries and the Purchasing Power Parity, we conclude that the regression coefficient between the price level differential and the exchange rate has indeed remained stable during the 20th century and find ample evidence supporting the PPP.

Keywords: cointegration estimators, PPP, structural change, small-sample properties, structural stability tests

JEL Classification: F31, C13, C22