On Purchasing Power Parity and Interest Rate Parity: Unit Root, Co-Integration, and Error Correction

We doubt the OLS regression results of tests of purchasing power parity (PPP) and uncovered interest rate parity (UIRP) and employ the notions of unit root, cointegration, and error correction to test the PPP and UIRP conditions in US-Japan and in US-Germany. We find that logarithm of the exchange rate, logarithm of relative price, difference of interest rates are non- stationary. Because of the non-stationarity of the variables, we check if there exists long-run relationship in PPP. Since logarithm of the exchange rate and logarithm of relative price are not co-integrated, we conclude that PPP and UIRP are not supported by our data.