Handbook of Exchange Rates

6.6 Modern Period: Testing of PPP

The principal use of PPP in historical research of the modern period (eighteenth century onward) is testing the validity of the theory. Although almost all investigators test the theory for its own sake, in effect, the degree of integration of the domestic with the foreign economy is assessed. Most, but not all, studies pertain to periods of a floating as distinct from fixed exchange rate.

6.6.1 Early North America

The earliest date of any PPP testing in this survey is the U.S. colonial period, and all authors paid attention to the stationarity issue. Bordo and Marcotte (1937) found that PPP holds under the South Carolina adjustably fixed exchange rate and proportionality could not be rejected. Choudhry and Luintel (1934) examined Pennsylvania under a floating exchange rate, and PPP results are mixed. Bernholz (1985) examined the period of the 13 colonies in rebellion, during which Congress issued Continental currency. During this paper standard and floating exchange rate, the price of specie (silver coin—representing the exchange rate) did not increase as much as the price index. Bernholz's explanation is the war-inflicted damage on production (supply) of goods and the British blockade, which reduced the value of specie (the currency used in payment for imports).

Grubb (2002, 1972, 1975) compared properties of the real exchange rate for six American colonies (later U.S. states) and Lower Canada in 1748–1775 (colonial period) versus 1796–1811 (Constitution ...