Deviation from Purchasing Power Parity: Evidence from Malaysia, 1973-1997

This paper presents an empirical test of Purchasing Power Parity (PPP) applied to the Malaysia ringgit for the period from 1973 (CPI) and 1984 (WPI) to 1997. Consistent with other research findings, it is detected that real exchange rate follows a random walk. Using multivariate cointegration methodology for the long‐run relationship between real exchange rate and certain macro‐economic variables, the study provides evidence supporting a long‐run relationship between the real exchange rate and the current account balance and government spending, the last two variables have been not included in previous studies of this economy. The causality test between real exchange rate with the current account balance and government spending, however, does not receive support from the error‐correction model. This suggests that both government spending and current account balance are not adequate to explain the changes in ringgit real exchange rate. The puzzle still remains unsolved.