The productivity-bias hypothesis and the PPP theorem: new evidence from panel vector autoregressive models

In this paper, we use panel vector autoregressive models to test both the purchasing power parity (PPP) relation and the productivity-bias hypothesis for Sweden vis-a-vis nine of its major trading partners (Denmark, Finland, France, Germany, Italy, Japan, Norway, the UK, and the US) for the period 1973-1999. The departure from earlier studies of the productivity-bias hypothesis and the PPP theorem is in the asymptotic theory of panel co-integration allowing for multiple co-integrating vectors. It has been demonstrated that the weak version of PPP receives strong support. Our findings also show that in the Euro-country cases, the deviation of PPP from the equilibrium exchange rate has a long-run relationship with the productivity ratios, implying that as Sweden becomes relatively more productive, the Swedish SEK appreciates in real terms. The results have policy implications for monetary integration in Europe, and in particular for Swedish participation in the European Monetary Union (EMU). (C) 2003 Elsevier Science B.V. All rights reserved.