Why statistical tests should reject the purchasing power parity hypothesis even when it holds

What is it about?

We show why, when the PPP hypothesis is tested using real exchenge rates computed using price indexes, real exchange rate are non-stationary even if the PPP hypotheis holds.

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Why is it important?

There are thousand (check on Google Scholar) of papers on the "purchasing power parity puzzle". Here, we show that a major problem in finding PPP, even when it holds, consists in an aggregation issue due to the way real exchange rates are computed. We give sufficient conditions to build real exchange rates in a way that preserves the PPP when it holds.

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