Can We Explain the Long-Term Real Equilibrium Exchange Rates through Purchasing Power Parity?
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Purchasing Power Parity (PPP) is the most conventional and fundamental means through which the long-term equilibrium exchange rate can be explained. This article examines the monthly and quarterly data from January 1965 - January 1995 aiming at testing the validity of PPP as a long-term equilibrium condition for the bilateral exchange rates between US Dollar and the currencies of a set of five industrialized countries, namely Germany, France, Australia, Canada, and the United Kingdom, using Augmented Dickey Fuller (ADF) unit root test. Results indicate that both monthly and quarterly US Dollar - Canadian Dollar real exchange rates are stationary. In case of US Dollar- Australian Dollar real exchange rate, only monthly data is found to be stationary. Strong evidence emerges that US Dollar - French Franc, US Dollar - German Mark, and US Dollar - Great Britain Pound exchange rates are non-stationary, which invalidates the PPP hypothesis.
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