An Empirical Test of Purchasing Power Parity Theory for Euro and US Dollar vs the Algerian Exchange Rate

The goal of this study is to examine the existence of Purchasing Power Parity(PPP) between the Euro and US dollar against the official as well as the black marketexchange rate of the Algerian dinar, through an empirical study covering various stagessuch as unit-root test, The Johansen cointegration test, CUSUM and CUSUMSQ tests, theimpulse responses and variance decomposition, applied to monthly data for the period 2003M1 – 2015M5. Results suggest that the administrated official exchange rate is not suitableto support the purchasing power parity (PPP) hypothesis. However, there is strong evidencethat Black market exchange rate presents long-run purchasing power parity, suggesting thatthere is long run relationship between black market exchange rate and relative prices indomestic and foreign markets. The use of black market exchange rate, which represents realequilibrium for market forces rather than the official exchange rate, might reflect thepuzzling role of the exchange rate policy to maintain stable purchasing power parity (PPP)in Algeria.