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TESTING LONG-RUN PURCHASING POWER PARITY UNDER EXCHANGE RATE TARGETING

Sophocles N. Brissimis

Bank of Greece and University of Piraeus

Dimitris A. Sideris

Bank of Greece and University of Ioannina

Fragiska K. Voumvaki

National Bank of Greece and Athens University of Economics and Business

ABSTRACT

The present paper exploits the idea that empirical estimates of the long-run PPP relationship may compound two distinct influences coming from the behavior of market participants and policy makers when the latter are targeting the exchange rate. This tends to bias tests of long-run PPP against its acceptance. The validity of the theoretical arguments is assessed by drawing on the experience of two European Union countries, Greece and France for the post-Bretton Woods period. Estimation biases due to the omission of policy effects are found to be significant only in the case of Greece. For France, our test results provide evidence bearing on the effectiveness of the competitive disinflation strategy pursued by the French authorities.

Keywords: Long-run PPP; exchange rate targeting; intervention policy; multivariate cointegration

JEL classification: C32; F31; F33

We are grateful to Harris Dellas, Heather Gibson, James Lothian and George Tavlas for helpful comments. The views expressed in this paper are those of the authors and do not necessarily reflect those of their respective institutions.

Correspondence:

Sophocles N. Brissimis,
Economic Research Department
Bank of Greece, 21 El. Venizelou St.
102 50 Athens, Greece
Tel. +30210-320 2388
Email: sbrissimis@bankofgreece.gr


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