Purchasing Power Parity and Emerging South East Asian Nations

Abstract

This paper provides a test of purchasing power parity (PPP) as an explanation for longterm foreign exchange rate movements. It essentially extends the analysis of Cheung and Lai (1993) to the South East Asian nations, Indonesia, the Philippines, Malaysia, South Korea, and Thailand. Consistent with Cheung and Lai, we impose symmetry and proportionality restrictions flowing from the absolute form of purchasing power parity (PPP) as well as applying the less restrictive Johansen test of PPP to data drawn from the period 1972 through 1997. The tests are also run for sub-periods with similar results. Symmetry and proportionality restrictions find little support in the unit root tests though the Johansen tests suggest that the foreign exchange rate and inflation rates are linked in a long run sense. Error correction models are then estimated on the basis of the assumption that the USA inflation rate is exogenous with respect to the selected emerging South East Asian nations. The error correction models vary considerably across the countries though one consistent result is the negative relation between the foreign exchange rate and the error correction parameter and the generally positive relation between the local CPI and the error correction parameter. The impact of the USA CPI on the countries varies considerably, ranging from no impact in the case of Indonesia through to a statistically significant impact on both the foreign exchange rate and local CPI for South Korea.