TESTIN`G THE VALIDITY OF THE PURCHASING POWER PARITY THEORY FOR THE WESTERN BALKAN COUNTRIES

The aim of this research is to empirically examine the long-term validity of the Purchasing Power Parity (PPP) theory in the Western Balkan countries—Bosnia and Herzegovina, Serbia, Montenegro, North Macedonia, and Albania—in relation to the U.S. dollar. The study applies modern methodological techniques for testing the stationarity of time series, including univariate ADF, PP, and KPSS tests, as well as panel SURADF tests, both in their classical form and with the inclusion of a Fourier component. The univariate tests indicate that real exchange rates are non-stationary in levels but become stationary after first differencing, implying that standard tests do not confirm the validity of the PPP theory. The classical SURADF test also does not provide strong evidence of stationarity, except in the case of North Macedonia. However, the extended SURADF test with a Fourier function consistently rejects the null hypothesis of a unit root for all analyzed countries, indicating the existence of a long-term equilibrium in real exchange rates. To the best of our knowledge, this study represents the first systematic application of the Fourier-augmented panel SURADF unit root test to the empirical testing of the Purchasing Power Parity hypothesis for Western Balkan economies. By explicitly allowing for smooth nonlinear structural changes, the applied methodology significantly enhances the detection of mean-reverting behavior in real exchange rates that conventional linear and panel unit root tests fail to identify. The findings therefore provide robust empirical support for the long-run validity of the PPP hypothesis in the region and offer relevant implications for exchange rate policy formulation and assessments of international competitiveness.