Purchasing power parity vs. uncovered interest rate parity for NAFTA countries: The value of incorporating time-varying parameter model

Jong Cheol Yoon, Dai Hong Min and Sang Young Jei

Economic Modelling, 2020, vol. 90, issue C, 494-500

Abstract: In 1994, the United States, Canada, and Mexico signed the North American Free Trade Agreement (NAFTA) to strengthen economic cooperation. To examine the effects of the NAFTA, this study revisits Purchasing Power Parity (PPP) for NAFTA countries by applying a time-varying cointegration model. Under the time-varying assumption, it improves the explanatory power of reality via the model specification test. Given that, the validity of PPP for NAFTA countries varies over time. Especially, the PPP elasticity based on the consumer price index (CPI) is more volatile than the producer price index (PPI) -based. Thus, the stabilization policy of the consumption sector must be a high priority over the production sector. Moreover, the validity of the Uncovered Interest Rate Parity (UIRP) is examined by the time-varying cointegration model. The aim is to compare the results of the PPP and UIRP. This suggests that the PPP is more useful than the UIRP in evaluating the movement of the exchange rate in the long-run.

Keywords: Purchasing power parity; Exchange rate determination; A time-varying cointegration model; A time-invariant cointegration model (search for similar items in EconPapers)
JEL-codes: C22 F31 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:90:y:2020:i:c:p:494-500

DOI: 10.1016/j.econmod.2019.11.034

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