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European exchange rate regimes and purchasing power parity: An empirical study on eleven eurozone countries

Chao-Hsi Huang and Chih-Yuan Yang

International Review of Economics & Finance, 2015, vol. 35, issue C, 100-109

Abstract: It is widely believed that following the adoption of the euro, long run purchasing power parity (PPP) is more likely to hold within the euro countries. By applying the panel unit root test of Pesaran (2007) to real exchange rate data of eleven euro countries for the sample period of January 1957 to May 2013, we find that, contrary to the above intuition, the evidence for the mean-reverting in real exchange rates is much weaker in the post-1998 euro period than in the pre-euro period. In contrast, we find that for the four countries not using the euro: Norway, Sweden, Switzerland, and the UK, the evidence for the mean-reverting in real exchange rates is strong in both the pre- and post-euro (post-1998) periods. Moreover, through our panel estimation of the error correction model using the common correlated effects (CCE) estimators a la Pesaran (2006), we find that the flexibility of nominal exchange rates is crucial for the adjustment of real exchange rates to PPP.

Keywords: Nominal exchange rate regime; Purchasing power parity; Real exchange rate; Panel unit root test; Error correction model (search for similar items in EconPapers)
JEL-codes: F31 C12 C23 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1016/j.iref.2014.09.008

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