Testing the Validity of Purchasing Power Parity For The Jordanian Economy

Transcription

1 Tesing he Validiy of urchasing ower ariy For The Jordanian Economy Abu-Lila, Ziad Ghazo, Abdallah To Link his Aricle: hp://dx.doi.org/ /ijarems/v7-i4/5418 DOI: /IJAREMS/v7-i4/5418 Received: 30 Oc 2018, Revised: 25 Nov 2018, Acceped: 27 Dec 2018 ublished Online: 06 Jan 2019 In-Tex Ciaion: (Abu-Lila & Ghazo, 2018) To Cie his Aricle: Abu-Lila, Z., & Ghazo, A. (2018). Tesing he Validiy of urchasing ower ariy For The Jordanian Economy. Inernaional Journal of Academic Research in Economics and Managemen Sciences, 7(4), Copyrigh: 2018 The Auhor(s) ublished by Human Resource Managemen Academic Research Sociey ( This aricle is published under he Creaive Commons Aribuion (CC BY 4.0) license. Anyone may reproduce, disribue, ranslae and creae derivaive works of his aricle (for boh commercial and non-commercial purposes), subjec o full aribuion o he original publicaion and auhors. The full erms of his license may be seen a: hp://creaivecommons.org/licences/by/4.0/legalcode Vol. 7, No. 4, Ocober 2018, g hp://hrmars.com/index.php/pages/deail/ijarems JOURNAL HOMEAGE Full Terms & Condiions of access and use can be found a hp://hrmars.com/index.php/pages/deail/publicaion-ehics

2 Tesing he Validiy of urchasing ower ariy For The Jordanian Economy Abu-Lila, Ziad Faculy of Economics and Adminisraive Sciences, Deparmen of Economics, Finance and Business, Al- Albay Universiy, Mafraq, Jordan Ghazo, Abdallah Al- Albay Universiy Faculy of Economics and Adminisraive Sciences, Deparmen of Economics, Finance and Business, Al- Albay Universiy, Mafraq, Jordan Absrac This sudy aims o invesigae he validiy of he hypohesis in Jordan over he periods ( ), using he exchange rae for Jordanian dinar in erms of he US dollar. To carry ou he objecive of his sudy graphical approach, saionary es and Coinegraion es are used. The empirical resuls of he hese ess rejec he for Jordanian economy. These resuls affeced by he rade obsacles, ransacion coss and he price differences beween counries. Keywords: Coinegraion Tes, Jordan, urchasing ower ariy, Saionary Tess, Trade. Inroducion The urchasing ower ariy () hypohesis is considered as one of he old hypohesis in he inernaional economy fields, which was laer used in many heories of he inernaional economy. The hypohesis was inroduced firsly by he Swedish economis (Gusan Cassel) in 1918, he is using i as a basis for evaluaing official exchange raes for counries a he end of he Firs World War. Thereafer, he hypohesis has become widely used by cenral banks and policymakers as an indicaor o evaluae currency when i deviaes from heir equilibrium values (Shapiro, 2006). The purchasing power pariy hypohesis saes on ha he prices of idenical goods in differen counries will end o be equal in he long erm, since he exchange rae will be adjused o eliminae he profi opporuniy ha can be achieved by purchasing a good from a paricular counry and hen selling i in high priced counry. Therefore, he hypohesis is considered as an exension of he one price law when i applied on he level of he economy as a whole. Where he one price law saes on ha he 193

3 idenical goods end o be sold a he same price in any wo separae markes when here are no ranspor coss, differen axes beween he wo markes or any ype of rade barriers. In conras o ha, if differen prices prevail in he markes, here will be opporuniies o make profis by buying he commodiy from low-priced markes and selling i in high-priced markes. As he buying and selling process coninues, prices will end o be equaed hrough he supply and demand forces. Due o he difficuly of eliminaing rade barriers, he hypohesis remained subjec of many applied research in inernaional economic sudies, especially afer he collapse of he Breon Woods sysem in 1973 and he ransiion o he floaing exchange rae sysem. Mos of hese sudies indicaed ha he hypohesis failed o be hold in he shor erm and in he long erm here is no definiive resul (Nusair, 2003). However, he hypohesis remained a heoreical basis for deermining he exchange rae and considered as a ool for making comparisons beween he counries. Therefore, he imporance of his sudy is relaed o he imporance of hypohesis which considered as an imporan indicaor for cenral banks and policymakers o evaluae he currencies. Furhermore, Holmes (2001) sees ha he hypohesis has a poenial ineres o policymakers in less developed counries (LDCs) for wo reasons: firs, he hypohesis is a mehod o evaluae he exchange rae and deermining he overvaluaion or undervaluaion of currencies. second, mos heories ha focus on he deerminans of exchange rae used some noion of he hypohesis in heir srucure. This sudy aims o examine he validiy of he hypohesis in Jordan. In order o achieve his objecive, he sudy used a se of economeric ess which applied o he annual daa for Jordanian economy over he period ( ) ha exraced from inernaional financial saisics. Finally, his sudy consiss of five secions. Afer reviewing he firs secion of he sudy, which included he inroducion and he imporance of he sudy, he second secion shows he heoreical framework and some previous lieraure ha deal wih he purchasing power pariy hypohesis. The hird secion presens an overview of he mehodology and sandard mehods ha used o achieve he objecive of he sudy, he empirical resuls are presened in he fourh secion and he las secion repor he conclusion of his sudy. Lieraure Review The general formula of he purchasing power pariy hypohesis saes ha he cos of idenical goods and services in differen counries will end o be equal in he long run. This hypohesis can be expressed in wo forms: absolue purchasing power pariy and relaive purchasing power pariy. Where he absolue purchasing power pariy hypohesis suggess ha he exchange rae beween any wo counries will equal he relaive prices beween hem, as in he following formula: e = *...(1) Where: e : The exchange rae in period, : The domesic prices level in period and * : The foreign prices level in period. 194

4 This formula includes ha he rise or fall in domesic price level relaive o foreign price level will lead o he appreciaion or devaluaion of he domesic currency in relaive o foreign currency. Bu under his assumpion of inegraed goods and markes (Al-Zyoud, 2015). This assumpion is no achieved in he real world, herefore he possibiliy of he absolue hypohesis o valid is difficul. This problem leads o relaive form of he hypohesis. The relaive hypohesis saes on ha he percenage change in he exchange rae beween wo counries during any ime period is equal o he difference beween he percenage change in price levels beween he wo counries during he same period of ime (Lafrance and Scembri, 2002). The relaive formula of he wries as he following: e e e 1 1 = 1 1 * * 1 * 1...(2) Since here is no definiive resul abou he long-erm purchasing power pariy () hypohesis, many applied sudies have examined he validiy of he hypohesis in is absolue and relaive form in order o evaluae he value of he exchange rae, especially during he insabiliy imes. Some of hese sudies acceped he hypohesis and ohers rejeced his hypohesis. Therefore, he hypohesis remains an open quesion, in spie of is imporance o cenral banks and policymakers. revious sudies used differen echniques o es he validiy of he hypohesis in he shor run and in he long run. Also, hese sudies differed in he objecive of he sudy, some of his concern on he absolue form while oher concerns on he relaive form of he hypohesis. Anyway, he following par of his sudy presen overview of some of his sudy. In order o measure he impac of base counry and es ype on he acceping or rejecing he purchasing power pariy hypohesis, Abumusafa (2006) esed he hypohesis in Jordan using more han one uni roo es and wih hree differen base counries. He found ha he accepance or rejecion of he purchasing power pariy hypohesis in Jordan was influenced by he ype of es. On he oher side, he indicaed ha in Jordan is no sensiive o he choice of base counry. Choong e al. (2006) examined he validiy of he hypohesis in absolue and relaive form using a se of economeric echniques applied o a group of Asian counries during he period ( ). The resuls of his sudy indicae ha he absolue hypohesis was no hold for he seleced counries, while he resuls indicae he validiy of he relaive hypohesis. In order o include some srucural changes during he sudy period, Ocal (2013) used he Ziro-Andrews sabiliy es which applied o he Romanian economy using annual daa during ( ). The resuls of his sudy reached o rejec he hypohesis. Al-Gasaymeh and Kasem (2015) esed he srong and weak forms of he purchasing power pariy hypohesis beween Jordan and is major rading parners, based on monhly daa covering he period ( ). The resuls of his sudy show ha. he real exchange rae in each counry is nonsaionary, which means he long-run fails o hold for all counries. Also, he Johansen coinegraion es ha used o es he weak form of, showed ha here exiss a coinegraing relaionship beween exchange rae, domesic and foreign price levels for all he counries. This resul is evidence on he weak form of he beween Jordan and is major rading parners. 195

5 Al-Zyoud (2015) used he Engle-Granger coinegraion es o invesigae he long-erm movemen beween he Canadian dollar and he US dollar using monhly daa for he period ( ). The resuls of his sudy show ha he absolue form of he purchasing power pariy () does no hold. Also, The resul shows ha here is no coinegraion beween acual exchange rae and rae, suggesing ha here is no long run relaionship beween he Canadian dollar and he US dollar exchange raes. Merza (2017) esed he purchasing power pariy () hypohesis during ( ) using monhly daa of Kuwaii economy. The resuls of he saionary ess indicaed a rejecion of he purchasing power pariy hypohesis for he Kuwaii economy. Also, afer referring o he componens of he real exchange rae, he researcher poined ha price level in boh Kuwai and America no move in a such way ha ensure he saionary of he real exchange rae. The researcher explained his resuls by he huge increase in he prices of he housing and food secors in Kuwai during he sudy period. Yilanci e al. (2017), invesigaed he validiy of he hypohesis for 14 African counries during he period ( ) using monhly ime series. The resuls of his sudy indicae ha he uni roo es failed o provide evidence of ha, he real exchange raes for hese 14 counries have mean-revering endencies. On he oher side, he coinegraion es deecs a long-erm sable relaionship beween he nominal exchange rae and he relaive price level for 8 counries. Daa and Mehodology To es he validiy of he purchasing power pariy hypohesis for he Jordanian economy, his sudy used daa from he inernaional financial saisics. he daa consiss of daa on he Jordanian consumer price index ( J ) and he US consumer price index ( U ) afer convering he base year ino Also, he daa include daa on he exchange rae beween he Jordanian dinar and he US dollar, which is expressed in he erms of he amoun of he Jordanian dinar ha needed o purchase one uni of he US dollar (S JU ). These daa were used o calculae he real exchange rae (RS JU ) using he following formula: U JU JU RS = S...(3) J The previous sudies used several economeric echniques o es he validiy of he hypohesis. In his sudy wo echniques employed o examine he validiy of he hypohesis for he Jordanian economy, he firs: he graphical approach, and he second: he economeric ess. Through he graphical approach, he validiy can be esed by drawing he rends of exchange rae and he exchange rae, which can be calculaed using he following formula, based on he work of Crownover e al. (1996):, JU S B Where: JU S S = S JU JU B J J ( / B ) U U ( / ) B...(4) is he hypoheical exchange rae based on he hypohesis for he period is he acual exchange rae which is expressed in erms of he amoun of he Jordanian 196

6 dinar ha needed o purchase one uni of he US dollar for he base year (B), consumer price index in he period, U J B is he US consumer price index in he period, and J is he Jordanian is he Jordanian consumer price index for he base year, U B is he US consumer price index for he base year. Based on he graphical approach, if he hypohesis is hold, hen he rends of exchange rae and he exchange rae will move ogeher across ime. On he oher side, he economeric ess ha used o examine he validiy of he hypohesis include, firsly: he saionary es of ime series o examine he saionary of he real exchange rae variable. Based on his es if he saionary of real exchange rae is failing o rejec, hen he hypohesis is acceped. This is because he purchasing power pariy hypohesis ha relae o he One rice law sae on ha, afer removing he ranspor coss, axes and ariffs, he commodiy will be sold in differen counries for he same price (Michael and aricia, 2003). In order o carry ou he saionary es he presen sudy applies he Augmened Dickey- Fuller (ADF) es, which is depending on he following regression: Y = + T + Y + Y i i i= 1 n...(5) Where: Y : he sudy variable (real exchange rae), ε he error erm, T he ime rend and n he opimal lag which needed o eliminae he auocorrelaion from esimaed regression, and i deermined hrough he Akaike Informaion Crieria (AIC). If he calculaed value (in absolue erm) is greaer han he criical value exraced from he Mackinnon able, hen he null hypohesis of he non-saionary of daa is rejeced (H0: = 0), and he alernaive hypohesis is acceped, which means he series is saionary a he level and inegraed of degree zero (Gujarai and orer, 2009). The accepance of he alernaive hypohesis implies ha he hypohesis is hold in a srong form. The oher economeric es ha used o examine he validiy of he hypohesis in Jordan depend on he Johansen's coinegraion es beween he nominal exchange rae and he relaive prices. This es used o es he null hypohesis ha sae on ha: here is r or less of he coinegraion vecors beween he sudy variables (nominal exchange rae and relaive prices), and o deermine which vecor is a saisically significan co-inegraion relaionship, he sudy used he following ess: 1) Trace Tes: race = T ln(1 i ) k i= r+ 1...(6) 2) Maximal Eigenvalue Tes: max = T ln( 1 r+ 1)...(7) Where: T number of observaions, k number of variables, λ values of calculaed Max Eigen value, and r number of coinegraion vecors. On he basis of hese ess, if he hypohesis 197

7 ha here is no coinegraion beween he relaive prices and he nominal exchange rae is rejeced, hen he hypohesis is acceped in he long erm. The Empirical Resuls The mehodology of his sudy depends on several ess o examine he validiy of he hypohesis in Jordan. Firsly: he graphical approach which depends on he graph o show he rend of he exchange rae and he exchange rae over he sudy period, as in he following figure: exchange rae exchange rae Figure (1): he exchange rae and he exchange rae in Jordan over he period ( ) I is clear from he previous figure he exchange rae and he exchange rae did no move ogeher across ime, especially afer he sabilizaion of he Jordanian dinar exchange rae agains he US dollar in Therefore he hypohesis do no hold of he Jordanian economy. The second es depends on he Augmened Dickey-Fuller es o examine he saionary of real exchange rae, he resuls of his es represened in he following able: Table (1): saionary es for real exchange rae Wih inercep Wih inercep and rend Tes Calculaed value Criical value a 5% Calculaed value Criical value a 5% ADF Table (1) repors he resuls of he ADF ess for he real exchange rae when an inercep alone and inercep and rend are included in he ADF equaion. According o his resul, he real exchange raes is no saionary in all cases. hillips-erron () es also used o es he saionary of real exchange rae, he resuls of his es indicae ha he hypohesis of non 198

8 saionary is also acceped a he 5% level. These resuls suppor ha he hypohesis fails o hold for he Jordanian economy. The final es ha used in his sudy o examine he validiy of he hypohesis in Jordan is he coinegraion es beween he relaive prices and he nominal exchange rae. The firs sep before applying he coinegraion approach depends on he saionary es of relaive prices and he nominal exchange rae as shown in he following able: Table (2): saionary es for he relaive prices and he nominal exchange rae Variable A level A firs difference Calculaed Criical value a Calculaed Criical value a value 5% value 5% Relaive rices * Exchange Rae * * Saionary a 5% level Afer esing he saionary es for he relaive prices and he nominal exchange rae, he resul shows ha he variables are saionary a firs difference. Therefore, he coinegraion es can be carried ou o examine he validiy of he hypohesis in he long run. Table (3) shows he resuls of coinegraion es beween he relaive prices and he nominal exchange rae. Table (3): Johansen's coinegraion es Hypohesis Trace Saisics Criical value a 5% level Max-Eigen Saisics None A mos Criical value a 5% level The resuls of race and max-eigen value indicae ha here is no coinegraion beween he relaive prices and he nominal exchange rae a 5% level, which means he hypohesis is no hold in he long run for Jordanian economy. Conclusion This sudy invesigaes he validiy of he hypohesis in Jordan over he periods ( ), he exchange rae for Jordanian dinar in erms of he US dollar are used in his sudy. The validiy of he hypohesis is imporan for cenral bank and policymakers o predic he behavior of he exchange rae. Since he economeric echniques have an impac on he resuls of he ess his sudy used differen echniques o es he validiy of he for Jordanian economy hese ess includes: graphical echniques, saionary ess and coinegraion es. The empirical resuls of he hese ess rejec he for Jordanian economy. In Jordan, he reason for he price difference in he las years reurn o ha he mos commodiies were subsidized by governmen. Also, ranspor coss and he rade obsacles on rading some goods affec on he price level beween counries. Therefore, he hypohesis can' be used o predic he exchange rae in Jordan. 199

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