Proceedings of 13th Asian Business Research Conference

Proceedings of 13th Asian Business Research Conference
26 - 27 December, 2015, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-93-1
Purchasing Power Parity (PPP) Validity with Structural Break
and Mean Reversion in Real Exchange Rate: The Case of
Bangladesh Taka and US Dollar
Javed Bin kamal and Abu N.M. Wahid
This paper aims at examining the validity of purchasing power parity (PPP) both in
absolute and relative senses and the long run behavior of the real exchange rate of
Bangladesh relative to USA. In doing so, the paper tests the presence of meanreversion in the real exchange rate by using the unit root test approach i.e. Augmented
Dickey-Fuller, DF-GLS, Zivot-Andrews tests. The paper verifies the long run relationship
on co-integration and VAR framework. Using monthly data (01/2007-06/2013) and
annual data (1986-2014), the paper finds support for both absolute and relative PPP,
with an evidence of structural break for only monthly data (Quandt -Andrew test and
CUSUM test) .VECM applied on monthly data, as there exists co-integrating equations
for only monthly data (by using Johansen test ). Unit root test indicates that the real
exchange rate is not a stationary i.e. I (1) series. The other time series, such as nominal
exchange rate, Bangladeshi CPI and the US CPI are also I(1) series. There are some
policy implications of our findings. First, we recommend that the local price level be kept
under control, because rising local price levels relative to those of the US will lead to
depreciation of Bangladesh Taka. Second, persistent trade deficit and Balance of
Payment crisis may result from devaluation of local currency resulting in such adverse
effects as capital flight, slow growth, rising unemployment, poor standard of living, etc.
Third, export diversification and competitiveness is required to ensure the functioning of
a stable exchange rate regime. Finally, a well-balanced and sound monetary policy
would be warranted to guarantee stable currency that is ultimately expected to promote
economic growth and macroeconomic stability.
Javed Bin kamal, East west University,
Professor Abu N.M. Wahid, Tennessee State University