PANEL DATA LINEAR METHODS IN INVESTIGATING THE LONG-RUN PURCHASING POWER PARITY THEORY FOR A GROUP OF DEVELOPED COUNTRIES

Abstract

The purchasing power parity (PPP) theory says that the nominal exchange rates between two
nations ought to be equivalent to the ratio of the total price levels between the two countries.
This study utilized the Pedroni test of cointegration to check if cointegration holds, further, the
study used the dynamic ordinary least square (DOLS) and fully modified ordinary least square
(FMOLS) in investigating the relationships between the nominal exchange rates and the
domestic and foreign prices in order to say what that means for the countries involved. The paper
found support for the PPP, and also, it was discovered that the domestic prices cause
depreciation while the foreign prices cause appreciation on the nominal exchange rates.
Consequently, depreciation of the nominal exchange rates will cause exports to be cheaper,
imports more expensive and hence cause inflation to increase. Appreciation of the nominal
exchange rates on the other hand will cause export to be more expensive, imports cheaper and
hence reduce inflation in the 16 developed countries.