In his comment on my paper. Imad Moosa makes some interesting points regarding recent tests of the purchasing power parity (PPP) hypothesis. More specifically, he raises some issues that may be interpreted as general points on the PPP literature and some that are specific comments on my paper. In this note I shall address only these points that apparently conflict with remarks made in my paper.

Abstract

In his comment on my paper. Imad Moosa makes some interesting points regarding recent tests of the purchasing power parity (PPP) hypothesis. More specifically, he raises some issues that may be interpreted as general points on the PPP literature and some that are specific comments on my paper. In this note I shall address only these points that apparently conflict with remarks made in my paper.

In his comment on my paper. Imad Moosa makes some interesting points regarding recent tests of the purchasing power parity (PPP) hypothesis. More specifically, he raises some issues that may be interpreted as general points on the PPP literature and some that are specific comments on my paper. In this note I shall address only these points that apparently conflict with remarks made in my paper.

It is correct to say, as Moosa argues in the second paragraph of his comment, that if prices in equation (17) of MacDonald (1995) are I(1) then a pure first difference version of PPP (with an error term added) would represent a violation of conventional PPP and support for efficient markets PPP. I agree, and spent some time making this point in the paper.

Moosa argues that I should not have used the expression Cassellian PPP because “Cassel’s view of PPP … is simply an extension of the quantity theory of money applied to the case of an open economy.” I am in total agreement that in his writings Cassel placed considerable emphasis on the monetary aspects of PPP (and indeed this view is noted on p. 441 of my paper). However, this is not inconsistent with my label of Cassellian PPP. First. it is clear from Cassel’s writings (see, for example, Officer (1976)) that it is arbitrage in internationally traded goods that links prices across countries (why else would Cassel spend time discussing the effect impediments to international trade could have on PPP holding?). If there is no arbitrage why would exchange rates necessarily track their PPP value rather than some other value? It is also very clear from Cassel’s writings that this arbitrage need not necessarily force PPP at all times (see Officer (1976)) for a fulsome discussion of this point). My term “Cassellian PPP” was simply a convenient way of making the point that a proponent of traditional PPP would not necessarily expect exchange rates always to be at their PPP values.

It is correct to say that the single equation methods of Engle and Granger may be modified to allow inferences to be drawn from coefficient estimates and, indeed, one such method is discussed at some length in my paper (pp. 461–62). My discussion of the Engie–Granger method on pp. 454–55 was intended to motivate the papers discussed on page 455. none of which adopted the correction advocated by Moosa.

Moosa argues that in testing PPP “there is more evidence for symmetry than for proportionality.” I have no problems with this assertion and, in fact, reported some evidence to this effect in the paper (see Table 2).

REFERENCES

  • MacDonald, Ronald, “Long-Run Exchange Rate Modeling: A Survey of the Recent Evidence,” Staff Papers, International Monetary Fund, Vol. 42 (September 1995), pp. 43789.

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  • Officer, Lawrence H., “The Purchasing-Power-Parity Theory of Exchange Rates: A Review Article,” Staff Papers, International Monetary Fund, Vol. 23 (March 1976), pp. 160.

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Ronald MacDonald is Professor of International Finance at the University of Strathclyde.