Ppp and Uip Between United States and Germany
PPP and UIP Between United States and Germany
Economics 423 Essay
Eddie Ng
ID# 977460
University of Calgary
Running Head: PPP & UIP Between US & Germany
PPP and UIP Between United States and Germany Exchange of goods between various countries has dominated the international trade market today. To compensate the differences in the rate of inflation between two countries, appropriate exchange rate has to be implemented. Exchange rate is the price of one currency in terms of another. Exchange rates are among the most important prices in an open economy because of the strong influence on the current account and other macroeconomic variables (Krugman et al., 2000). One example of the macroeconomic variables is relative purchasing power parity (PPP). Another important macroeconomic variable, similar to purchasing power parity, is the uncovered interest parity (UIP). The empirical validity of purchasing power parity and uncovered interest parity will be examined via two countries, the United States and Germany. In Anker (1999), the idea that UIP puzzle was due to the consideration of the risk premia in relation to the change in exchange had been introduced by McCallum (1994). McCallum also suggested that the tradeoff between interest-rate and exchange rate stability produced an additional bias in the probability limit of the slope coefficient β in the UIP regression. Culver & Papell (1999) demonstrated statistically, using KPSS tests, that the combination of rejecting the stationary null hypothesis for nominal, but not for real, exchange rates constitutes evidence of long-run PPP. Finally, Engel (2000) argued that long-run PPP may not hold after all, since tests on long-run PPP tend to have serious size biases under many common statistical tests such as the Augmented Dickey-Fuller test (ADF), Error-Correlation Model (ECM), and the Horvath-Watson test (HW). There may be a significant result that is not
Economics 423 Essay
Eddie Ng
ID# 977460
University of Calgary
Running Head: PPP & UIP Between US & Germany
PPP and UIP Between United States and Germany Exchange of goods between various countries has dominated the international trade market today. To compensate the differences in the rate of inflation between two countries, appropriate exchange rate has to be implemented. Exchange rate is the price of one currency in terms of another. Exchange rates are among the most important prices in an open economy because of the strong influence on the current account and other macroeconomic variables (Krugman et al., 2000). One example of the macroeconomic variables is relative purchasing power parity (PPP). Another important macroeconomic variable, similar to purchasing power parity, is the uncovered interest parity (UIP). The empirical validity of purchasing power parity and uncovered interest parity will be examined via two countries, the United States and Germany. In Anker (1999), the idea that UIP puzzle was due to the consideration of the risk premia in relation to the change in exchange had been introduced by McCallum (1994). McCallum also suggested that the tradeoff between interest-rate and exchange rate stability produced an additional bias in the probability limit of the slope coefficient β in the UIP regression. Culver & Papell (1999) demonstrated statistically, using KPSS tests, that the combination of rejecting the stationary null hypothesis for nominal, but not for real, exchange rates constitutes evidence of long-run PPP. Finally, Engel (2000) argued that long-run PPP may not hold after all, since tests on long-run PPP tend to have serious size biases under many common statistical tests such as the Augmented Dickey-Fuller test (ADF), Error-Correlation Model (ECM), and the Horvath-Watson test (HW). There may be a significant result that is not