Purchasing Power Parity In The Brazilian Real Plan Economics Essay

1-INTRODUCTION

In this undertaking, the focal point will be addressed to the Purchasing Power Parity ( PPP ) and its pertinence in the Brazilian economic system from 1995 until 2009, which means after the high rising prices period. Given that in these period non many plants has been written. And since the theory of Buying Power Parity is of import to contrast and measure the standard of populating between two or more states taking into consideration their exchange rates and its impact in the economic system.

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Technique of Cointegration and unit root trial will be applied in this undertaking to inspect this hypothesis for the exchange rate market efficiency in Brazil. As said above, the spotlight period will be from 1995 because it will reflect how the economic program applied in early 1994 at the Brazilian economic system, best known as “ Real Plan ” , has worked out. And after that ambitious economic undertaking, we can look into if the market exchange rates are being efficient.

It is of import to bear in head that flexible and fixed exchange rates were used at Brazilian economic system in this period, though Enders ( 1988 ) reminds that cointegration can be applied to gauge the PPP relationship under fixed and flexible exchange rates.

2-LITERATURE REVIEW and THEORY

After a deep currency crisis in Brazil, where in merely under 30 old ages ( June 1965 to June 1994 ) an rising prices of 1.142.332.741.811.851 % was registered, harmonizing to General monetary value index of the period, the most of import economic undertaking has taken topographic point, chiefly to undertake that rising prices phenomenon. The program intended to stabilise the domestic currency in nominal footings. Back in the beginning of that economic program at July 1994, the exchange rate government was fixed. But in January 1999 after a currency crisis in Brazil, as a consequence from de 1997 Asiatic crisis and the 1998 Russia crisis, that fixed-exchange rate government was over given so a flexible or drifting government to vigour.

So, based on monthly informations covering January 1995 to September 2009, cointegration and unit root trials of monetary value index in Brazil and USA, and exchange rates between both states will be conducted. USA is one of the chief commercial spouses of Brazil, reacting for more than 20 % of Brazil`s exports.

The PPP has become a really of import tool presents in many developed states since it analyses the long term balanced exchange rate of two or more currencies to equalise their buying power. And for developing states is an of import device to command and measure rising prices. In the Brazilian instance, it is non different where the exchange rate is closely related with rising prices, in add-on to it the “ existent program ” successfully tackle rising prices, turning about 25 million people into consumers, so the PPP will be critical to compare differences in life criterions between states. For case, harmonizing to IMF ( International Monetary Fund ) , XXCHECARXX China is the 2nd economic system power of the universe, utilizing PPP step, with the GDP of U $ 5.970 per capita. When utilizing nominal footings the GDP per capita is merely around U $ 3250. Therefore, PPP can convey a GDP of developing states into the same or even higher degrees of developed countries` GDP.

The term PPP was foremost used by Gustav Cassel ( 1918 ) , but history Tells that the construct is linked to the University of Salamanca in the 16 century. PPP, harmonizing to Ramirez and Khan ( 1999 ) is comparatively simple and straightforward, and applies the jurisprudence of one monetary value to an equal basket of goods across states. In other words, the same basket of goods in state Ten costs the same in state Y if the currencies are exchanged at that rate. On the other manus, in malice of being simple in theory, PPP is rejected in many instances in response of inside informations such as market disequilibrium, import/export limitations, travel costs, location, among others.

To specify PPP, Rogoff K. ( 1996 ) , used these words: “ buying power para is disarmingly simple empirical proposition that, one time converted to a common currency, national monetary value degrees should be equal. The basic thought is that if goods market arbitrage enforces wide para in monetary values across a sufficient scope of single goods, so there should besides be a high correlativity in aggregative monetary value degrees. ”

Knowing that PPP can be hard to keep in some instances, two hypothesis of PPP were developed, absolute and relation. “ The purchasing-power-parity ( PPP ) theory involves the ratio of two states ‘ monetary value degrees ( absolute PPP ) or monetary value indices times a basal period exchange rate ( comparative PPP ) as the most of import variable finding the exchange rate, but it allows both for other explanatory variables and for random influences. ” ( Officer, L. 1976 ) .

So, in the absolute PPP hypothesis exchange rate between the currencies of two states is determined by the monetary value degrees of those two states. It can be written as:

( 1 )

Where E will be the nominal exchange rate measured in units of currency A ( Brazilian Real ( BR $ ) ) per unit of currency B ( United States dollars ( US $ ) ) , P will be monetary value degree in state A, and P* will be the monetary value degree in state B. It besides can be written in logs equation ( 1 ) as:

( 2 )

On the other manus, comparative PPP hypothesis states that “ the ratio of the equilibrium exchange rate in a current period ( T ) to the equilibrium exchange rate in a basal period ( O ) is determined by the ratio of the domestic country`s monetary value index in period T, where both indexes are measured comparative to period O. ” ( Officer, L. 1978 ) . This can be written, in logs as:

( 3 )

where it is developed the hypothesis of I? = 1 for the equation above, which would connote perfect accommodation of to motions in. And the intercept is consistent with the comparative version of PPP, which requires merely that domestic and foreign monetary value degrees move proportionally.

A comparative version of PPP will be used in the present paper, given the fact that absolute version was tested in many occasions and in its bulk the theory could non keep or be accepted for its cogency. And instead, comparative PPP takes into consideration differences in the rates of rising prices between two states, conveying a more accurate analysis.

The informations are monthly, as mentioned above, for the period runing from first month 1995 to September 2009. Therefore 177 observations, which could assist to accomplish the long-term relationship scrutiny demanded by the theory and empirical trials of PPP. Yet, as Kugler and Lenz ( 1993 ) reminds us, despite 15 to 20 old ages appears to be big, in long-term analysis for the hypothesis of PPP that period is non big.

All the variables to be used in the survey of the equation 3, what are monetary value degree in the US ( P* ) and monetary value degree in Brazil ( P ) are based on the Wholesale Price Index ( WPI ) . “ This is standard in the literature, which is based on the fact that the WPI gives a more accurate step of the monetary values of traded goods than does the consumer monetary value index ( CPI ) ” ( Sanchez-Fung, J. 1999 ) . In both instances, the monetary value indexes were taken from the International Monetary Fund`s International Financial Statistics. Just as a affair of information, in the US the WPI is better known as manufacturer monetary value index ( PPI ) . The exchange rate ( E ) of the R $ /US $ used in this analysis is the ‘sell rate ‘ for foreign exchange in Brazil, and Central Bank of Brazil ( BACEN ) is the beginning.

3 – ECONOMETRIC Mold

As Sanchez-Fung J. ( 1999 ) reminds us one time more, to use the cointegration technique find the grade of integrating of each variable is needed as a first measure, and in this present paper the equation 3 will be submitted to the trial to find the grade of integrating. And the Augmented Dickey-Fuller ( ADF ) trial is good used as a first measure for this intent, raising the order of integrating among exchange rate and derived function of the monetary value degrees between the those states.

“ The series, and are likely to be nonstationary, they have to be differenced one time in order to go stationary. ” ( Kugler P. , Lenz C. , 1993 ) . So, after estimation a arrested development like ( 3 ) and obtain the remainders, the ADF trial will be used on the OLS remainders. If the void hypothesis is rejected it can be said that we have cointegration. Therefore, the cointegration analysis is taken at a two measure attack of Engle and Granger dynamic signifier. Guajarati S. , ( 2004 ) good states: “ Economically talking, two variables will be cointegrated if they have long term, or equilibrium, relationship between them. Economic theory is frequently expressed in equilibrium footings, such as PPP. ” He adds: “ The valuable construct of unit roots, cointegration, etc. is to coerce us to happen out if the arrested development remainders are stationary. ”

Estimating equation 3, by aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦.. produces the undermentioned result:

By the figure aˆ¦.. 1aˆ¦.. is easy to construe some events, such as the devaluation of the exchange rate in beginning of 1999, when the authorities changed the policy from fixed to flexible exchange rate government, which increased the country`s competitivety in the external sector. Other event, was in 2002 when a presidential running brought as a consequence another devaluation of the exchange rate, rapidly recovered. And last but non least, the downswing of 2008 can be seen on the graph every bit good.

4 – Decision

5 – BIBLIOGRAFY AND REFERENCES

Enders, Walter ( 1988 ) Arima and Cointegration trials of PPP under fixed and flexible exchange rates governments, Review of Economics and Statistics, 70 ( 3 ) : 504-08

Dickey, D.A. and W.A. Fuller ( 1979 ) : Distribution of the Calculators for Autoregressive Time Series with a Unit Root, Journal of the American Statistical Association, 74, p. 427-431.

Gujarati, Damodar ( 2004 ) Basic Econometrics, Fourth Edition, New York, The McGraw-Hill Companies.

Kugler, Peter and Lenz, Carlos ( 1993 ) Multivariate Analysis and the long tally cogency of PPP, The reappraisal of Economics and Statistics, vol. 75, No. 1 ( feb. , 1993 ) , pp. 180-84. Pblished by: The MIT Press

Officer, Lawrence H. ( 1978 ) The relationship between absolute and comparative Purchasing Power Parity, The reappraisal of economic sciences and statistics, vol. 60, No 4 ( nov. , 1978 ) , pp. 562-568 Published by: The MIT Press.

Ramirez, Miguel D. , Khan, Shahryar ( 1999 ) A cointegration Analysis of Buying Power Parity:1973-96, International Advances in Economic Research, vol. 5, No. 3 ( 1999 August ) , pp. 369-85.

Rogoff, Kenneth ( 1996 ) The Buying Power Parity Puzzle, Journal of Economic Literature, vol. 34, No. 2 ( jun. , 1996 ) , pp. 647-668. Published by: American Economic Association

Sanchez-Fung, Jose R. ( 1999 ) Efficiency of the black market for foreign exchange and PPP: the instance of the Dominican Republic, Applied Economic Letters, 6, 173-176

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