Variation in Purchasing Power Parity of UK and USA in Terms of Periods, Indices Lags, Periodicity - Statistics Project Example

Central Question: Is there any variation in Purchasing Power Parity of UK and USA in terms of time periods, indices lags, periodicity (i.e. monthly quarterly

International Finance

Section 1: introduction

The project defined in our study is defined to answer the above sited question. This can be achieved by identification of similar group of products in UK and USA. The principality behind this measure using a common commodity or service is to establish the Purchasing Power Parity (PPP) in its relative form. It is therefore very important to assume that the there exists some difference in the commodity price in the two case study country markets, UK and USA. The difference in market prices will indicate or lead a researcher to rejection or acceptance of the hypothesis under test. In case of price difference, we shall reject the hypothesis of relative form of PPP in UK and USA.

The project paper is meant to provide possible solutions to how, why and what causes inflation rates and variation in PPP. It also explains into details what is the impact intensity of PPP on the consumer price index and in general the exchange rates which influence rates of local and international investments. To better understand the factors and how they influence investment within a country, we need to understand into depth how exchange rates and inflation rates correlate.

Our analysis will provide an investigation of the exchange rates between UK and USA within the period of 2013 to 2015. This will be based on the statistical test of PPP between the two case study countries. PPP is a significant in international finance that permits necessary modifications on the exchange rate occurring between countries theeby helping us to gauge the purchasing power associated with the subject currencies. An analysis in SPSS, we shall aid in generation of regression analysis on a quarterly basis. We will also perform a statistical test to examine if difference really exists on the exchange rates in UK and USA. The results of this analysis can therefore be used latter in furthering and controlling investments in the two countries, UK and USA.

In other words, our statistical analysis in this case will employ the PPP theory in exchange rates prediction in future quarters. Likewise, it can provide a good prediction tool for investigating the inflation rates in the two countries. We should therefore deny the relative form of PPP and is thus difficult to put into practice to control inflation rates in UK and USA.

Section 2: Significance for International Finance

The general backbone of macroeconomics widely depends on quite several metrics. This is considered to important for the macroeconomists to understand and make conclusions on the economic productivity in two case study countries. It can as well be important in prediction of the living standards in two different countries with varying currency values over some time.

Generally, the theory of PPP is based on the assumption that real cost of a product or service consumption in one country equals the real consumption cost in another country. This is only acceptable after accounting for the difference in the exchange rates. The importance of this is that it offers macro economists with an opportunity to generate estimates on global productivity and growth rates in two countries. Moreover, it can be useful in detection of the overvalued or undervalued currencies. This enables investors to make best decisions regarding investments.

The significance of PPP to International Finance body is direct. It provides some good metrics that are useful in prediction and generation of the economic recommendations for economic growth plans to investors. The impacts are usually short run and hence not a long term solution to International Finance organization.

Section 3: Test design

For as to make an analysis, we obtained relevant datasets from the database of EIU data for USA and UK from 2013 to 2015. The data was obtained from the international monetary fund website, http://dx.doi.org/10.5257/imf/ifs/2013-12. Our data analysis was done on a quarterly basis. To proceed with the test, exchange rates were determined for the two countries for the period 2013-2015, based on quarterly basis. 2013-2015 was considered because data for the 2013 going forward were not readily accessible. Data was later converted to enable quarterly analysis. It was also necessary to review the data and obtain the essential exchange rates for both United Kingdom and United States of America.

In summary, calculation of the PPP ratio can be obtained by the formula below. We need to find the ratio of the prices of a common commodity in UK and USA a a particular market time.

S= P1/P2, Where P1 is the cost of commodity “Y” in UK currency, P2 is the cost of commodity in UK currency and S is the exchange rate of USA DOLLARN to the GDG.

Likewise, we had to obtain the Cross rate currency for the two countries from the website. To test for the hypothesised assumption statement, it was necessary to make an analysis of variance to draw possible conclusion.

In our analysis, we decided to make an analysis of variance to test for the significance of the PPP. The assumption was made on purchasing power of a common commodity in UK and USA within the period of 2010 to 2012. An ANOVA table for the variance analysis was generated and copied into word document for latter interpretation.

Section 4: Test results

First we testi

Series Name

Country Code

2007

2008

2009

2010

2011

2012

2013

2014

PPP conversion factor, GDP (LCU per international $)

USA

1.00

1.00

1.00

1.00

1.00

1.00

1.00

1.00

PPP conversion factor, GDP (LCU per international $)

GBR

0.65

0.65

0.66

0.69

0.70

0.70

0.69

0.70

The table above indicates the PPP data for actual individual consumption from year 2008 to 2014. As shown by the data, there is increase of the relative PPP with time thereby making us to conclude that pound sterling is depreciating against the US$. We can also confirm this by performing analysis of variance on PPP data for the country.

When performing the analysis, the relevant dataset was transferred into SPSS. This software was preferred over the Stata and excel as it provided a simple methodology in making analysis of variance. From the result of one way ANOVA test, we proceeded to do a further test as it could not compute the F-RATIO with N<30. Below is a t-test analysis for the hypothesis test on acceptance or rejection of the hypothesis of equal means in USA and UK for the period between 2010 - 2012. Possible hypothesis were formulated as follows.

H0: the quarterly means for the two countries are equal from 2010 to 2012

H1: the quarterly means are different.

ANOVA

Sum of Squares

df

Mean Square

F

Sig.

q012013

Between Groups

Within Groups

Total

1.651

.000

1.651

1

0

1

1.651

.

.

.

q012014

Between Groups

Within Groups

Total

8.426

.000

8.426

1

0

1

8.426

.

.

.

q012015

Between Groups

Within Groups

15.296

.000

1

0

15.296

.

.

.

Total

15.296

1

One-Sample Test

Test Value = 0

t

df

Sig. (2-tailed)

Mean Difference

95% Confidence Interval of the Difference

Lower

q012013 quarters 1

123.318

1

.005

112.03450

100.4909

123.5781

q012014

56.301

1

.011

115.55750

89.4780

141.6370

In relation to the t-test, we proceed by NOT rejecting the null hypothesis. For instance, we can conclude that the mean quarterly expenditure in both UK and USA are not equal.

The conclusion is that the difference is significant. This variation may be as a result of currency rates of conversion among the two countries over the researched period gap. The data for inflation indicates that UK has exhibited higher rates over the years as compared to US; the rate of inflation change over the years is also higher than that registered by US. This higher inflation has significant impact on exchange rate because it dictates the value of currency within any given time. Hence, this is enough evidence that PPP is real between the two countries. In other words, we can conclude that the Purchasing Power Parity in the two countries, UK and USA vary significantly over the sampled quarters from 2013 to 2015. Likewise, it is possible to conclude the generality that PPP has significant impacts in the economic growth of the two countries. Micro economists should therefore look for best solution approaches to solve and make comparisons of the living standards in these two countries with different currencies.

Section 5: Data

The data used to perform the test was obtained from the website as already indicated before. The World Bank Website contains quite a varied amount of financial datasets. Our choice for the base period of 2013 was selected to generate conclusions based on current trends in the financial sector of world economy.