Purchasing power parity for 15 Latin American countries: Panel SURKSS test with a Fourier function

a r t i c l e i n f o JEL classification: C23 F31 Keywords: Purchasing power parity Panel SURKSS test with a Fourier function Latin American countries This study applies Panel SURKSS test with a Fourier function to investigate the properties of long-run purchasing power parity (PPP) in fifteen Latin American countries over the period of December 1994 to February 2010. The empirical results from the univariate unit root and panel-based unit root tests indicate that PPP does not hold for these fifteen countries under study. However, results from the Panel SURKSS test with a Fourier function indicate that PPP is valid for these fifteen countries, with the exception of Honduras. Our results highlight the importance of incorporating both nonlinearities and structural breaks when testing the validity of long-run PPP. These results have important policy implications for these fifteen Latin American countries under study. During much of the past few decades, a plethora of studies has centered on the investigation of the stationarity of the real exchange rate The results from such studies are not only valuable for empirical researchers and policy makers, but they have also unveiled extremely important implications in international finance. To be more to the point, a non-stationary real exchange rate indicates that any long-run relationship between the nominal exchange rate and domestic and foreign prices is virtually non-existent, therefore invalidating the theory of purchasing power parity (hereafter, PPP). In this event, PPP cannot be used to determine the equilibrium exchange rate; what's more, the invalidation of PPP disqualifies any monetary approach to determining the exchange rate since that would necessitate that PPP holds true. 1 Empirical evidence of PPP on the stationarity of the real exchange rate is abundant, but unfortunately, thus far, the consensus has not yet reached. For details about previous studies, see the work of MacDonald who have provided in-depth information on the theoretical and empirical aspects of PPP and the real exchange rate. Recently, there is a growing consensus that real exchange rate exhibits nonlinearities and, consequently, conventional unit root tests, 1 According to Holmes (2001) and Sarno (2005), PPP is important to policymakers for several reasons. First, it can be used to predict the exchange rate and determine whether a currency is over-or undervalued, which is particularly important for less developed countries and countries experiencing large differences between domestic and foreign inflation rates. Secondly, the notion of PPP …