ABSTRACT

The purchasing power parity (PPP) hypothesis postulates that the same basket of goods and services should cost the same amount in all countries when expressed in a common currency. PPP is expected to hold true in the long run, although deviation of exchange rate from PPP might occur in the short run, due to factors such as transaction costs, price rigidity, the differential composition of market baskets and price indices, and imperfect markets (as a result of subsidy, taxation, trade barriers, foreign exchange market interventions and the like). However, previous empirical studies have reported mixed results. For instance, the work of Lee (1976), Glens (1992), Lothian and Taylor (1996), Coakley and Fuertes (1997), Nagayasu (1998), Razzaghipour et al. (2001) and M. Azali et al. (2001) are all supportive of the long-run PPP hypothesis, whereas authors like Corbae and OutHaris (1988), Edison and Fisher (1991), Engel et al. (1997), O’Connell (1998), Baum et a l (1999) and Cuddington and Hong (2000) provide empirical evidence against PPP, even as a long run relationship. Meanwhile, Salehizadeh and Taylor (1999) produce mixed results, in the sense that only about one-half of 27 selected emerging economies under their investigation are supportive of PPP, while the other half are not.