Re-Examination Of The PPP Theory

Purchasing Power Parity (PPP) theory has far-reaching effects in the theory of exchange rate determination, however, the discussion on its rationation, criticism and verification has been one of the focus of the international financial field and there is still no uniform results. In addition, as one of the methods on the equilibrium real exchange rate research, PPP theory have a key role in guiding policies. Since financial crisis in2008, the pressure on RMB appreciation among western countries is growing. Does RMB exchange rate exists miscalculated or need correction? These are the problems to be solved urgently.For a long time, the stability test of the real exchange rate is widely used in the test of PPP. With the continuous development of econometric methods, panel unit root test has been widespread concerned, and is widely used in the empirical research in the past decade. This paper summarizes the development of PPP theory research from two aspects, then followed by an empirical test of this theory based on panel data model.Firstly, we test mean reversion of the real exchange rate based on the "first generation " panel unit root method. The result shows that PPP theory holds. However, there is no account in interact influence between exchange rate for the "first generation" panel unit root method, that is, it’s based on the assumption that cross-sectionally independent. In fact, this is not in line with the actual situation.Secondly, based on the fact that the cross-section dependencies of the exchange rate between the countries, we relax the limitation assumptions that the panel data is independent along the cross sections such as the first generation tests. That is, under the cross-sectionally dependent panel framework, we use the "second generation" panel unit root test to re-verify the theory of purchasing power parity. Specifically, through the empirical test and analysis of the21emerging markets, we use block bootstrap method to simulate the asymptotic distribution of the statistics to get a more reasonable and more accurate test results. The empirical results show that the purchasing power parity theory does not hold in the emerging market countries.Given these findings, the paper then select BEER method combined with China’s special situation to build RMB equilibrium exchange rate calculation model, using cointegration analysis method to estimate the equilibrium real exchange rate and the exchange rate misalignment. It turns out that in the study period, the RMB real effective exchange rate of overestimation and underestimation of alternating ups and downs of the phenomenon, which in2005and2008exchange rate misalignment is relatively large, but in general there is no serious disorders.Finally, we present some reasonable explanation, analysis and discussions for the empirical testing results. Some future research topics in the field are given in chapter five.