Panel Econometric Approaches to Purchasing Power Parity: A Survey of Methods and Findings

ABSTRACT

This paper surveys the development of panel econometric approaches to testing purchasing power parity (PPP), focusing on how methodological advances have addressed key empirical challenges that limited earlier time‐series evidence. We review the evolution of methods designed to account for cross‐sectional dependence, parameter heterogeneity, and structural breaks, and assess how these developments have influenced conclusions regarding PPP validity. A central finding is that first‐generation panel methods, which assume cross‐sectional independence, tend to provide stronger support for PPP, whereas second‐generation approaches that explicitly model interdependence across economies often yield weaker evidence. The survey also highlights the importance of base currency choice and shows that panel cointegration studies generally support weak PPP while rejecting stricter proportionality conditions. Evidence incorporating productivity differentials and structural breaks tends to strengthen support for PPP. Despite substantial methodological progress, estimates of exchange rate adjustment remain slow, leaving the persistence of real exchange rate deviations‐and the broader PPP puzzle—only partially resolved.