Real exchange rate shocks, asymmetric adjustment and long-run equilibrium in less developed countries

This paper investigates the possibility that long-run relative purchasing power parity is dependent upon the nature of real exchange shocks that are experienced. While existing studies involving developed and less developed countries often find against purchasing power parity having employed linear tests of non-stationarity or non-cointegration, we employ a new cointegration test, recently advocated by Enders and Siklos and Enders and Dibooglu, that tests for an asymmetric adjustment towards parity with respect to positive and negative real exchange rate shocks. Using a sample of ten African economies with data taken from the post-Bretton Woods floating exchange rate era, long-run purchasing power parity holds in eight of these cases if an explicit distinction is made between positive and negative shocks. Across the sample, we find variation in the type of asymmetry experienced and the roles played price and nominal exchange rate adjustment.