Strong and Weak Form of Purchasing Power Parity: The Case of Jordan and its Major Trading Partners

The aim of this paper is to test two forms of purchasing power parity (PPP), specifically the strong form of PPP and the weak form of PPP between Jordan and its major trading partners namely, Japan, United Kingdom, Turkey, and United State, based on data covering the period of 2000M1-2012M12. First, this paper examines the strong form of PPP to test the stationarity of the real exchange rate. The results show that the real exchange rate in each country is nonstationary. This implied that the long-run PPP fails to hold for all countries. In the second stage, the Johansen cointegration test employed to test the weak form of PPP. The results of cointegration tests showed that there exists a cointegrating relationship for all the countries between exchange rate, domestic and foreign price levels. We conclude that the evidence of weak PPP is found between Jordan and its major trading partners. The unit-root tests of real exchange rates imposed proportionality and symmetry restrictions that nominal exchange rates and aggregate prices move together in a one-to-one fashion. The weak form of the PPP states that the nominal exchange rate and aggregate price ratios may move together in equilibrium, but the relationship need not necessarily be one-to-one. This paper found evidence for weak PPP but not for strong PPP, hence, the conditions of proportionality and symmetry restrictions may be one of the reasons that PPP not hold when being tested empirically.