The theory of purchasing power parity (PPP) has worked poorly during t
he post-Bretton Woods period. We generalize the concept of PPP (called
generalized-PPP, or G-PPP) and posit an equilibrium relationship amon
g groups of real exchange rates. The basic tenants of G-PPP are that r
eal fundamental macroeconomic shocks tend to be non-stationary so that
the real exchange rates themselves will tend to be non-stationary. Al
though bilateral exchange rates are non-stationary, they will be coint
egrated if the vector of stochastically trending variables has reduced
rank. G-PPP will hold within the domain of a currency area since the
individual nations will experience a set of common real macroeconomic
shocks. Using data from the industrialized countries during the post-B
retton Woods period, we show that G-PPP holds for various groupings of
nations. We estimate the long-run equilibrium relationships among the
real exchange rates and the short-run dynamics concerning the interna
tional transmission of real disturbances. An interesting finding is th
at G-PPP does not hold among the set of major European nations. The di
rest implication is that such nations do not constitute the domain of
a currency area.