The author focuses on purchasing power parity and compares absolute purchasing parity (Absolute PPP) and relative purchasing power parity (Relative PPP). The author also gives an empirical evidence of absolute and relative purchasing parity and argument against it
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It states that the country which is having high inflation rate is weak in terms of currency because inflation reduces the real purchasing power of a nation’s currency. It predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period which means that the exchange rate of two currencies reflects the effect of inflation rate (Murphy, p.1). Absolute PPP states that the value of 2 currencies changes in contrary proportion to the changes in the ratio of price levels. On the other hand relative, PPP predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period. Absolute PPP is based on the law of one price that is tested for a basket of commodities or individual commodities. The relative PPP approximates the change in individual price by change in price indices. Empirical evidence of absolute PPP: An orange costs 3 dollars in country A and the same orange costs 6 dollars in country B. This means 3 dollars in country A equals to 6 dollars in country B. This exchange rate is based on the cost of orange and it is assumed that the cost of orange is same worldwide. Empirical evidence of relative PPP: Japan’s anticipated annual rate of inflation is equal to 6% per year, while the anticipated annual inflation rate for the U.S. is 3%. As an approximation, it is expected that the Japanese yen would devalue at the rate of 4% a year. The whole concept is based on unrealistic assumptions. That’s why forex market does not take into consideration the purchasing power parity. Those assumptions were a basket of goods and services in the CPI is the same in all countries, no transportation cost, and consumptions patterns are the same all over the world.
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This essay evaluates the determination of current account and international business co-movement. It does critical review of the operation of the international exchange rate systems. It predicts and conducts critical assessment on the financial and macroeconomic impacts of exchange rate fluctuations and exchange rate policies.
The paper aims at testing whether the real exchange rates that are depicted are mean reverting or not.
In the article, the author goes through a number of selected African countries, pointing out the application of the Purchasing Power Parity. In her
We used data from UK since previous research has shown that they are the most commonly used data set to test for Purchasing Power Parity (PPP).
Before conducting any serious analysis we ran some basic statistics. The table below gives a summary of the
It should be important to note that IRP assumes 2 distinct forms; covered IRP and uncovered IRP. Covered IRP may be described as the condition whereby a forward contract is employed to cover (eradicate exposure to) the risk of the exchange rate. Uncovered IRP, on the other hand, may be defined as the parity condition whereby foreign exchange risks.
In other words purchasing power parity is a technique used to determine the relative values of two currencies. This is a valuable tool because the value of currency of each nation is different. A Euro or a British Pound can buy more items than a US Dollar.
The author explains that the central notion of the purchasing power parity hypothesis is that the exchange rate between the currencies of two economies is determined by the relative price levels of the two countries. One could perceive this theory as saying that the changes in the exchange rate are driven by changes in the relative price levels.
I. Purchasing Power Parity
1) Generating Eviews work file
By inspecting the dataset Data_Canada_PPP.xls, it is analysed that the data consists of 3 series Exchange_rate (Canadian dollar to US dollar nominal exchange rate), CPI_Can (Canadian Consumer Price Index) and CPI_US (the US Consumer Price Index) that are observed every month from the year 1990/1 till 2011/3.
Developed in the early 1900s by a man named Gustav Cassel, this theory was based on the idea that in an ideal world with an efficient market, the same goods should have the same price universally.
The law of one price, which is the building block of the theory of the purchasing power parity, states that, "under free competition and in the absence of trade impediments, a good must sell for a single price regardless of where in the world it is sold" (Krugman and Obstfeld, 2000).
Malay, Mon and Khmer civilizations flourished in the reason prior to the arrival of ethnic “Tai”. Geographically the area of Thailand is 513,115 sq. km; equivalent to the size of France, or slightly smaller than Texas. Beautiful city of Bangkok is the capital of
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