An Empirical Test of Purchasing Power Parity Theory for Euro and US Dollar vs the Algerian Exchange Rate

Abstract

The goal of this study is to examine the existence of Purchasing Power Parity (PPP) between the Euro and US dollar against the official as well as the black market exchange rate of the Algerian dinar, through an empirical study covering various stages such as unit-root test, The Johansen cointegration test, CUSUM and CUSUMSQ tests, the impulse responses and variance decomposition, applied to monthly data for the period 2003 M1 – 2015M5. Results suggest that the administrated official exchange rate is not suitable to support the purchasing power parity (PPP) hypothesis. However, there is strong evidence that Black market exchange rate presents long-run purchasing power parity, suggesting that there is long run relationship between black market exchange rate and relative prices in domestic and foreign markets. The use of black market exchange rate, which represents real equilibrium for market forces rather than the official exchange rate, might reflect the puzzling role of the exchange rate policy to maintain stable purchasing power parity (PPP) in Algeria