Working Paper: CEPR ID: DP4510
Authors: Kees Koedijk; Ben Tims; Mathijs A. van Dijk
Abstract: This Paper analyses purchasing power parity (PPP) for the euro area. We study the impact of the introduction of the euro in 1999 on the behaviour of real exchange rates. We test the PPP hypothesis for a panel of real exchange rates within the euro area over the period 1973-2003. Our methodology exploits the cross-sectional dependence across real exchange rates and allows for heterogeneity in the rates of mean reversion. We present evidence in favour of PPP for the full panel of real exchange rates, but we show that accounting for cross-country differences within the euro area is essential. The unit root hypothesis can be rejected for some real exchange rates, but evidence for PPP is weak for others. We also investigate PPP between the ?synthetic? euro against several other major currencies over the period 1979-2003. We find support for the PPP hypothesis for the full panel of real exchange rates. When the restriction of a common mean reversion coefficient is relaxed, we reject the unit root hypothesis for the euro-Swiss franc rate only. We conclude that the process of economic integration in Europe has accelerated convergence toward PPP within the euro area.
Keywords: European Integration; Heterogeneous; Purchasing Power Parity; Real Exchange Rates
JEL Codes: F31; F33; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Maastricht Treaty (1992) (F36) | stationarity of real exchange rates (F31) |
| Introduction of the euro (1999) (F36) | stationarity of real exchange rates (F31) |
| Economic integration (F15) | convergence toward PPP (F62) |
| Unit root hypothesis rejection (C22) | mean-reverting behavior (C22) |
| PPP evidence for Finland, France, and Spain (H69) | mean-reverting behavior (C22) |
| No PPP evidence for Portugal (H42) | unit root null cannot be rejected (C20) |
| PPP with euro against Swiss franc (F31) | support for PPP (E64) |
| No PPP between euro area and US dollar (F31) | no support for PPP (E64) |