The Role of Nominal Exchange Rate and Relative Prices in Reversion Purchasing Power Parity in Iran

Document Type : Research Paper

Authors

Department of Economics, Faculty of Economics, University of Tehran, Tehran, Iran

Abstract

This paper investigates the relative contributions of nominal exchange rates and relative price adjustments toward PPP in a VECM framework in Iran. In conducting empirical tests, annual time series data were used covering the period of 1357 to 1401. The cointegration test indicates the existence of a long-run cointegrating relationship between the nominal exchange rate and relative price. Also, the adjustment speed coefficient of the real exchange rate resulting from the difference in the adjustment speeds of the variables of the VECM model is around -0/2. This value indicates the slow adjustment process in such a way that it is expected that 80% of the current period's deviation from purchasing power parity will remain for the next year. On the other hand, the evidence from impulse response functions shows that relative price shocks lead to much longer real exchange rate deviations than nominal exchange rate shocks. Also, the nominal exchange rate in response to the relative price impulse is slowly on its long-term equilibrium path; While the relative price reacts to the impulse of the nominal exchange rate, it is placed on the path of its long-term equilibrium at a faster rate. In general, it can be said that to establish purchasing power parity, the relative price will play a more important role than the nominal exchange rate. Thus, Iranian policymakers must pay attention to price stabilization and the reduction of high inflation rates through appropriate macroeconomic policy.
JEL Classification: C32, F31

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References

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Journal of Economic Research (Tahghighat- E- Eghtesadi)
Volume 58, Issue 3 - Serial Number 144
December 2023
Pages 529-542

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History

  • Receive Date: 26 October 2023
  • Revise Date: 11 November 2023
  • Accept Date: 03 December 2023

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