A century after its development, the purchasing power parity theorem, which links exchange rates with prices, remains one of the most popular and influential economic theories. This study examines the relationship between exchange rates and prices from the perspectives of causality and spillovers. Using a panel of countries and advanced statistical methods, we estimate spillovers for all combinations of origins and destinations at different frequency bands, and show that their relationship is time-varying and multi-directional and has some validity at short and long time horizons. Furthermore, using exchange rate regimes, economic structures, currency crises, and trade openness, we identify economic conditions influencing the size and direction of spillovers.
|Journal of International Financial Markets, Institutions and Money
|Published - 2021 Mar
- Data frequency
- High dimensional vector autoregression
- Purchasing power parity
- Variance decomposition