A Correct Test of Purchasing Power Parity: The Case of Pak-Rupee Exchange Rates

This paper presents some empirical evidence on long-run purchasing power parity (PPP) for eight Pak-rupee exchange rates over the period 1982:1–1994:4. Results obtained from testing for cointegration and coefficient restrictions using the Johansen (1988, 1991) procedure are supportive of PPP in almost all cases. These results are also supported by those obtained from testing for mean reversion in the real exchange rate using the Sims (1988) Bayesian test. One of the conclusions that emerge from these results is that devaluation of Pak-rupee vis-à-vis major industrial currencies under investigation may be unlikely to improve the country’s external competitiveness and, consequently, the deficit in its trade balance.