Inflation and Exchange Rates: An International Examination of Relative Purchasing Power Parity

Purchasing power parity (PPP) is an old and controversial proposition in economic literature. It is based on the law of one price, which argues that, after adjusting for the exchange rate, domestic and foreign price levels are equal. The relative version of PPP argues that exchange rate changes depend on the differential between domestic and foreign inflation rates. The absolute PPP version is based on restrictive assumptions that prevent it to hold in the short run. However, several studies support the validity of the relative PPP proposition in the long run. It is often observed that countries with persistently high inflation experience weak currencies. Our empirical testing using impulse response functions derived from a VAR model for eight countries provide mixed results. In six out of eight selected countries, relative PPP is supported by data in the long run.

The Swiss National Bank’s fear of float

We theoretically examine under which assumptions the impossible trinity holds. We also focus on the most recent Swiss experience and ask whether the SNB gained monetary independence by switching from a fixed to a floating exchange rate system in January 2015. The theoretical examination shows that the impossible trinity holds under the following assumptions: Equality of domestic and foreign real interest rates, the quantity theory of money holds, and that the relative PPP is fulfilled. The empirical analysis reveals that relative PPP does not hold for the Swiss case and it was necessary for the SNB to adopt its monetary policy in accordance with the ECB’s expansionary monetary policy. We show that for a small open economy, such as Switzerland, whether the central bank implements a fixed or a floating exchange rate system does not play a role in its monetary policy independence.

PENDEKATAN KESEIMBANGAN JANGKA PANJANG NILAITUKAR MATA UANG RUPIAH TERHADAP DOLAR AMERIKA (1973-1997)

The aims of this paper is to test Purchasing Power Parity for Indonesian currency to US dollar. The analysis used in this article is the long run equilibrium with cointegrated test approach.The result show that almost all variable in this model are stasionair in the first degree, but both variable s and p not cointegrated for the absolut PPP. The estimated result show that Pj=l hypothesis is not hold during 1974.4 -1998.3 period. In the other hand, cointegrated test for the variable dst and dpt in the relative PPP is cointegrated and the estimation result show that the Relative PPP and the Cochrane-orcutt model PPP is hold for Indonesia, except for the period when Indonesia had fixed exchange rates during 1974.4 -1986.3 period.