Testing for purchasing power parity: Econometric issues and an application to developing countries

There is now a vast literature on testing purchasing power parity (PPP), Any test is conditional. on a particular econometric specification which embodies a set of auxiliary assumptions. This paper reviews the issues involved in econometric specification and estimation in the time series and panel models used to test PPP. We start from a general model and then systematically examine the implicit restrictions that are imposed to obtain the standard procedures and discuss the implications of these procedures for estimation and inference. The issues are illustrated on data for a panel of 31 developing countries, 1966-90.