RE-EXAMINING THE RELATIVE PRICE-EXCHANGE RATE NEXUS

Abstract

Exchange rate is one of the key macroeconomic indicators in emerging markets. This study investigates the validity of purchasing power parity (PPP) hypothesis in Indonesia and Philippines over the period 2005(1)-2021(12). Unit roots tests reveal that the exchange rate in both countries reverts to its mean. From the autoregressive distributed lag model, we find that there is a strongly long-run PPP relationship but no significant short-run PPP relationship. Partitioning the source of exchange rate misalignment, we obtain that in Indonesia the effect of the relative price on the exchange rate appreciation is greater than that on exchange rate depreciation. Interestingly, in the Philippines where the relative PPP holds both in currency depreciation and appreciation, the effect of the central bank’s intervention is statistically insignificant. However, The CUSUM and CUSUMQ stability tests of the estimated results confirm that the PPP hypothesis in Indonesia and Philippines is robust for the long-run.