Journal of international money and finance vol:13 issue:5 pages:602-622
This paper tests the relative purchasing power parity (RPPP) hypothesis on month-by-month, post-1972 data, and still obtains regression coefficients that are close to unity. Two methodological aspects have contributed to this encouraging result. Firstly, although all RPPP tests are vis-a-vis the USA, we nevertheless exploit our a priori knowledge about the implications of these USD-based equations on PPP relations between cross-rates. So, in a sense, we use all information implicit in all cross-rates too. Secondly, we selected an instrumental variable that is specifically designed to cope with lead-and-lag effects in non-traded vs traded-goods inflation. Our estimates indicate that most lead-and-lag effects seem to occur within a six-month window.