Research Discussion Paper – RDP 8711 Deviations From Purchasing Power Parity: The Australian Case


The hypothesis that deviations from PPP follow a random process is tested against two alternatives that the real exchange rate reverts to a constant equilibrium level (long-run PPP); and that it reverts to an equilibrium level which is itself a function of shifts in commodity prices (long-run PPP doesn't hold, but for reasons that are predictable). The random walk hypothesis cannot be rejected if commodity prices are ignored or if the nominal exchange rate is fixed. It is consistently rejected when commodity prices are included and the exchange rate is floating.

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