Testing the Validity of Purchasing Power Parity: A Comparison of Sri Lanka and Pakistan

Abstract

This study investigates the strong and the weak relationship between macroeconomic variables and the purchasing power parity of Sri Lanka and Pakistan. Purchasing power parity is compared with the relative price level of identical product available in both countries. This paper includes 20 years of macroeconomic annual data from 1997 to 2016. These data have been analyzed using descriptive statistic, reliability test and time series multiple regression. Result reveals that real exchange rate is not constant in both economies of Sri Lanka and Pakistan, and this illustrates Sri Lanka has weak relationship between the purchasing power parity and exchange rate, inflation, interest rate, money supply, gross domestic product, foreign direct investment, whereas Pakistan has strong relationship between the selected macroeconomic variables and the purchasing power parity. This study helps enhance knowledge about how purchasing power parity affects the growth of the economies