Revisiting purchasing power parity in 34 OECD countries: sequential panel selection method

Since introduction of unit roots, researchers have tried to solve the purchasing power parity (PPP) puzzle or its failure by testing for stationarity of the real exchange rates. Failure to support the PPP is mostly said to be due to low power of these tests. Panel unit root testing is more prevalent due to at least increased size of the sample and relatively more power of the tests. Within the panel, since some rates could be stationary and some nonstationary, Sequential Panel Selection Method (SPSM) should be used to distinguish the series. Furthermore, since some series could suffer from unknown structural break, the SPSM should be supplemented with Fourier function. We apply these proposed procedures to real effective exchange rate data from 34 OECD countries from January 1994 to June 2012. We find that the PPP is supported in most members of the panel.