A Test Of Purchasing Power Parity (PPP) Theory And The International Fisher Effect: A Case Of The U.S. Dollar And The Japanese Yen

Abstract

The present paper discusses the theories of Purchasing Power Parity (PPP) and the International Fisher Effect dating back to the early years of the twentieth century, and tests their evidence for the recent time period data for the U.S. dollar – Yen exchange rate.  The results show that both these theories provide a  satisfactory explanation of the behavior of exchange rates.  One of the main reasons why these theories lost their explanatory power in recent years was the inflexibility of exchange rates in the Bretton Woods System.  However, as the exchange rates became flexible again in recent years, the theories have become more applicable.  It is further observed that the quarterly data are more relevant for these theories than the monthly data.