1 Suppose observe data on the pound dollar spot rate S($/£), the U.S. inflation rate π$, and the U.K. inflation rate π£. (a) Write down the regression equation we would run to test for purchasing power parity (PPP). What are the relevant hypothesis tests? (b) Suppose we run the regression and get the following results: ˆα = −0.03, SE( ˆα) = 0.08, ˆβ = 0.75, SE( ˆβ) = 0.20, and T = 60. Test the relevant hypotheses and report the 95% confidence intervals for α and β. Do the results support the PPP hypothesis?

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