Purchasing Power Parity : Evidence from Selected High and Low Inflation Countries

Abstract

This paper reexamines the long run relationship between nominal bilateral exchange rate and the price index ratio for high and low inflation countries using time series analysis techniques. Tests for non-stationarity were carried out before cointegration analysis was conducted. Theoretically, Purchasing Power Parity (PPP) should receive empirical support in the case of high-inflation countries. This is because PPP is a monetary phenomenon and monetary factors tend to overshadow real factors in high-inflation countries. The findings show that high inflation countries such as Sierra Leone and Mexico support the Theory of Purchasing Power Parity (PPP). In the case of low inflation countries, none of the countries provides evidence supporting theory of PPP.