PPP and structural breaks. The peseta-sterling rate, 50 years of a floating regime

This paper aims to illustrate the relevance of considering structural breaks in Purchasing Power Parity (PPP) tests. To that end, we examine the peseta-sterling real exchange rate between 1870 and 1935. This is an interesting series, given that the peseta was not part of the gold standard yet maintained a floating rate regime during most of that period. When breaks are not considered, it is impossible to reject the existence of a unit root in the series. However, if two breaks are allowed, with these capturing the particular events that occurred in the monetary history of these currencies at the beginning and end of the period, then the null hypothesis can be rejected and PPP emerges as a good approximation of the behavior of the peseta-sterling exchange rate, even if that rate was predominantly a floating regime.