An Empirical Test of Purchasing Power Parity in Selected African Countries - a Panel Data Approach

Abstract

The paper tests whether the theory of Purchasing Power Parity holds in a selected sample of twenty African countries. The paper employs a panel unit root test to test whether the real exchange rates in the panel are mean reverting or not. The test employed is the Im et al (1997) test. Results show that the null of a unit root is rejected for the three real exchange rate indices, namely, the import-based and trade-weighted multilateral indices, and the bilateral indices, while for the export-based indices, the null hypothesis is not rejected. That is, Purchasing Power Parity is confirmed for the import-based and trade-weighted multilateral indices, and the bilateral indices, while it is rejected for the export-based multilateral indices. After performing the demeaning adjustment to account for cross-sectional dependence, our results show that the null hypothesis of a unit root is rejected for the import-based multilateral indices and the bilateral indices, while the null is not rejected for the trade-weighted multilateral indices. Purchasing Power Parity is therefore only confirmed for the import-based multilateral indices and bilateral indices, while it is rejected for the trade-weighted multilateral indices.