Purchasing power parity

Purchasing power parity (PPP; english purchasing power parity, PPP, parity = equality of Latin par equal ' ) is a term macroeconomic analysis. The PPP between two geographic areas in the same currency area exists when goods and services of a basket can be purchased for the same large amounts of money. If two different currency areas compared, so the funds are made comparable by exchange rates. In this case, the purchasing power parity prevails when the different currencies through the foreign exchange rates have the same purchasing power and can thus buy the same basket. If purchasing power parity between two countries, there is, as corresponds to the nominal to the real exchange rate.

  • 5.1 International Comparison Program 5.1.1 Price system selection & Gerschenkroneffekt
  • 5.1.2 model
  • 5.1.3 results
  • 5.1.4 Criticism & Problems

Areas of application

The concept of purchasing power parity is used for a variety of applications:

  • As a long -term exchange rate theory (purchasing power parity theory ): As a result, foreign exchange rates or inflation adjust so that there is purchasing power parity between the two currency areas. The exchange rate at which the purchasing power in both currency areas is the same, is called purchasing power parity exchange rate.
  • As a correction factor: To make economic variables such as gross domestic product, gross national income, per capita income and absolute poverty internationally, a mere translation at current exchange rates is not sufficient, as the purchasing power can vary greatly in different currency areas. Typical concepts are here in purchasing power standard (PPS ) and the PPP U.S. dollars ( PPP $). Here, however, no indication of the economic strength is reached, but the level of activity and level of prosperity of the economies compared, since the calculated values ​​on KKS are fictitious.

Purchasing power parity theory

Basic concept

The purchasing power parity theory states that exchange rates between two currencies mainly therefore vary to compensate for differences in price levels. It is based on the principle of the law of one price. Accordingly, an estate would have to sell all over the world at the same price. Otherwise, there would be arbitrage opportunities. According to the theory, a unit of money in all countries must have the same purchasing power, it must have the same real value anywhere. This is also called absolute purchasing power parity.

The purchasing power parity theory is originally from the monetary international economics. It calculates how much units of the currency needed to buy the same representative basket of goods, which you could get for $ 1 in the USA. In the short term can vary the exchange rate from purchasing power parity, especially as monetary disturbances rapid changes in the exchange rate can cause, while the price level changes relatively slowly. In the long run however, it should fluctuate around this value. This is then called relative purchasing power parity.

As a pioneer in the purchasing power parity theory is Gustav Cassel, although there are approaches to it in the 17th century. Based on this interpretation and the interest parity theory developed Rudiger Dornbusch monetary exchange rate theory.

Criticism

The purchasing power parity theory is a simplified illustration of the principle, as are constituted exchange rates. Not included are in practice virtually transaction costs (transport costs, customs and taxes, as well as distortions by government trade restrictions ). Since the theory of Jevons ' law is based, the same conditions must apply. However, this is in reality hardly ever.

So Dornbusch and Fischer empirically show the example of the exchange rate of the DM and the U.S. dollar since the year 1979, that the theory is non-linear applicable in every case.

Another point of criticism is the current (low ) influence exerted by buying and selling currencies from commodity transactions on the exchange rate. According to the latest currency market statistics of the Bank for International Settlements in April 2007, the average daily turnover in the foreign exchange market is 3.210.000.000.000 (3.21 trillion ) dollars and has increased by 70% since the last survey in 2004. Only about three percent of the sales then come from stores.

Purchasing power parities as a correction factor

For international income comparisons international organizations identify ( eg World Bank) such purchasing power parities empirically to eliminate distortions caused by exchange rate fluctuations. So used the World Bank the term local purchasing power for their definition of poverty. In order to compare the income of the people, the purchasing power of the U.S. dollar in local purchasing power is converted. One U.S. dollar in local purchasing power is considered as minimum level that a person needs to survive.

Since many developing countries ( according to the purchasing power parity theory ) have undervalued currencies, their per capita income is in USD (USD ) purchasing power parities is usually higher than the official exchange rates prevailing.

A popular example of purchasing power parities on an alternative basis is regularly published by the magazine The Economist Big Mac index. It is determined how much a Big Mac costs in a McDonald's restaurant in the various countries of the world. These prices are taken on the basis of currency translation. Similarly, the iPod index. Here, the sales price of the iPod produced by Apple is compared in different countries. A major difference between the two indices is that iPods pose a tradable across borders, while Big Macs with no international trade is operated, which is why it can not come to equalizing arbitrage transactions of Big Macs.

Example Table

1997 had to be paid for one U.S. dollar about 1.43 Swiss francs. 1.43 divided by 0.62 (see table) results in 2.31 ​​; the purchasing power parity between the dollar and franc was accordingly 2.31 ​​. This means that in that year in Switzerland at CHF 2.31 ​​the same number of values ​​of commodities could be bought in the U.S. with U.S. $ 1.

According to the purchasing power parity theory of the Swiss franc against the U.S. dollar would be overvalued, because there would be an arbitrage opportunity. You could change francs in dollars, so buying in the U.S. goods and sell them at a profit in Switzerland. This francs would steadily changed in dollars, and the franc would depreciate in value. Only when the Swiss franc was devalued against the U.S. dollar on 62 % of its original value, no longer would this possibility and arbitrage would not be worth it.

Empiricism

International Comparison Program

The originally initiated by Irving Kravis, Alan Heston and Robert Summers research program of the World Bank compares economies by purchasing power parity theory.

The international comparison project (ICP ) tries to make a comparable economic performance of economies. A real comparison is often difficult because the exchange rate freely formed are often distorted (eg: China's foreign exchange interventions). Therefore, the ICP considers the pricing development of shopping carts according to the purchasing power parity approach to enable a more realistic investigation.

Price system selection & Gerschenkroneffekt

The choice of an appropriate pricing system proves to be difficult because despite the same economic efficiency - appear different powerful countries - because of different price levels. This distortion effect is also called Gerschenkroneffekt. The ICP chooses an average price system to reduce the Gerschenkroneffekt.

Model

The international prices (average price system ) can be defined as:

Which inversely gives to the purchasing power parity of the country j:

Explanation of symbols:

  • - International price of good i
  • - Price of good i in country j
  • - Purchasing power parity of country j
  • - Quantity produced of good i in country j
  • - World production of good i

Results

Compared with the conventional calculation on exchange rates:

  • Distance between the countries will be less
  • Service rate ( spending on services as measured by the gross national product ) is in development as well as industrialized countries similar (each about 1/3)
  • Investment rate ( investment expenditure measured by the gross national product ) is much higher in industrialized countries

Criticism & Problems

  • Statistical data collection find a comparable product to collect can ( especially difficult in services)
  • ⇒ distortion of international prices for the countries with a higher share of global production
Rudi Dornbusch Big-Mac-Index Portugal Brazil Free trade Balassa–Samuelson effect Maurice Obstfeld Federal Statistical Office of Germany Stanley Fischer
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