Cointegration tests of purchasing power parity among four industrial countries: results for fixed and flexible rates

The purchasing power parity (PPP) relationships for several industrial countries relative to the US are reestimated. These countries are the UK, Canada, and Japan. An examination is made of an extended time period spanning 1957I-1986VI to determine if PPP would fare better using an extended data set. Three periods are tested: 1. a fixed rate subperiod, 2. a flexible rate subperiod, and 3. an extended period encompassing both subperiods. Evidence favorable to PPP is marginal, with a number of test statistics bordering on significance at the 0.10 level. This evidence comes primarily from the wholesale price index, thus supporting the arbitrage view of PPP over the alternative, which stresses the overall purchasing power of money. The strongest support for cointegration comes from the fixed rate subperiod, when the Japanese and possibly the Canadian wholesale price indexes (WPI) form cointegrated systems with the US WPI. With the possible exception of the Canadian WPI, cointegration is rejected for the recent period of flexible exchange rates.