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Exchange rate and long-run price relationship in 19 selected European and LDCs

Augustine Chuck Arize (Economics and Finance Department, College of Business, The A&M University – Commerce, Commerce, Texas, USA)
Ebere Ume Kalu (Department of Banking and Finance, University of Nigeria, Enugu Campus, Enugu, Nigeria)
Chinwe Okoyeuzu (Department of Banking and Finance, University of Nigeria, Enugu Campus, Enugu, Nigeria)
John Malindretos (Cotsakos College of Business, William Paterson University of New Jersey, Wayne, New Jersey, USA)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 22 July 2019

Issue publication date: 17 April 2020

Abstract

Purpose

This study aims to make a comparative study of the applicability of the purchasing power parity (PPP) in selected less developing countries (LDCs) on one hand and European countries on the other hand.

Design/methodology/approach

The research design is empirical and ex post facto. This study uses an assortment of co-integration tests and error correction representation. The chosen approach allows for the consideration of long-run elasticities and the dynamics of the short-run adjustment of exchange rates to changes in domestic and foreign prices. Monthly data are used for the period 1980:1 through 2015:12 (i.e. 432 observations).

Findings

Results from long-run co-integration analysis, short-run error correction models and persistence profile analysis overwhelmingly confirm the validity of PPP in these two sets of countries regardless the disparity in their relative exchange rate and price characteristics.

Research limitations/implications

Curiously, several of these empirical studies and still many more, have focused their attention on the experiences of industrialized countries, with a few investigations devoted to LDCs. The evidence is even scarcer in Africa. Clearly, the acceptance of any hypothesis as a credible explanation of economic reality hinges on the robustness of the hypothesis across countries with different economic and institutional frameworks.

Practical implications

Knowledge of the extent to which exchange rate and relative prices can be linked in the long run is important for the design and management of inflation and the implementation of monetary policy. For instance, policy actions aimed at stabilizing the domestic economy can obtain results that are, at best, uncertain in the absence of correct characterization of the PPP dynamics. Moreover, structural and macroeconomic adjustment programs implemented in these countries to achieve economic growth and external competitiveness could be unsuccessful if flawed estimates of PPP exchange rates are retained.

Originality/value

Several empirical studies have been done to prove the validity or otherwise of the PPP. Unlike prior authors, this study makes a comparative study of the applicability of the PPP in selected LDC on one hand and European countries.

Keywords

Acknowledgements

Professor Arize thanks Professors Mark Rudin, John Humphreys and Lapelle Hendricks for their support and assistance; thanks to Kathleen Smith for research assistance.

Citation

Arize, A.C., Kalu, E.U., Okoyeuzu, C. and Malindretos, J. (2020), "Exchange rate and long-run price relationship in 19 selected European and LDCs", Journal of Financial Economic Policy, Vol. 12 No. 1, pp. 97-120. https://doi.org/10.1108/JFEP-08-2018-0117

Publisher

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Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited