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Purchasing Power Parity in a Transition Country: The Case of Croatia

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Abstract

We explore the validity of the purchasing power parity (PPP) hypothesis in the case of Croatia. Two cointegration methods were used: Johansen cointegration that assumes symmetry and threshold cointegration that allows for asymmetric adjustment in the short run. The results suggest that in the long run the absolute power parity condition holds, that is, that the exchange rate is aligned with the fundamentals and no depreciation is needed. The error correction model does not confirm the existence of exchange rate pass-through to domestic consumer prices. Threshold cointegration results suggest that the adjustment of deviations from PPP is not asymmetric.

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Notes

  1. Several other authors also concluded that nonlinear methods are more appropriate for testing PPP in developed countries. Using a theoretical model, Dumas (1992) showed that the speed of adjustment towards the equilibrium varies with the magnitude of the deviation from PPP. Accordingly, deviations then follow a nonlinear process. Taylor et al. (2001) showed that four major real bilateral US dollar exchange rates are characterized by a nonlinear mean reverting process. Thereby the real exchange rates behave more like unit root processes the closer they are to the long-run equilibrium. They become more mean reverting the further they are from equilibrium.

  2. Data for 2009 from Croatian Central Bureau of Statistics.

  3. Details about TAR and M-TAR models can be found in Tong (1983), Caner and Hansen (2001) and Enders and Siklos (2001).

  4. For the tests, we used the larger of the t values and F statistics that were later denoted by Tmax and Φ both in the text and in the corresponding tables.

  5. For the tests, we used F statistics that was denoted by W both in the text and in the corresponding tables.

  6. Note that restrictions related to long-run coefficients are written in vector notation.

  7. Tmax has to be equal to or less than −1.8, while the value of Φ statistics has to be equal to or greater than 8.

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Authors and Affiliations

  1. Institute of Economics, Trg J.F. Kennedya 7, Zagreb, 10000, Croatia

    Marina Tkalec & Maruška Vizek

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  1. Marina Tkalec
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  2. Maruška Vizek
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Tkalec, M., Vizek, M. Purchasing Power Parity in a Transition Country: The Case of Croatia. Comp Econ Stud 53, 223–238 (2011). https://doi.org/10.1057/ces.2011.3

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