Testing for purchasing power parity in South Africa in the presence of real shocks

Tests for purchasing power parity in the literature have had mixed results, particularly in the presence of real shocks. This paper tests the behaviour of the PPP relationship in South Africa between 1979 and 1992 using cointegration techniques. The period is divided into three sub-periods to take account of the various shocks to the economy and the changes in the policy regime. The results show that in the first two sub-periods, which were characterised by a variety of real shocks, there were divergences from PPP. The third period, which was relatively free of real shocks and characterised by more stable and consistent monetary and exchange rate policies, produced results consistent with PPP holding. This implies that given the recent decline in the inflation rate, and in the absence of further real shocks, the dilemma facing the SARB with respect to stabilising the nominal or real exchange rate may now have been diminished, and one might expect the exchange rate to follow its PPP path more closely than in the past five years.