1 Chapter 8: Purchasing Power Parity and Real Exchange Rates 熊家财 江西财经大学会计学院

2 Chapter 8: Purchasing Power Parity and Real Exchange Rates 8.1Price Level and Price Indexes 8.2The Purchasing Power of a Currency 8.3Absolute Purchasing Power Parity 8.4The Law of One Price 8.5Describing Deviations from PPP 8.6The MacPPP Standard 8.7Exchange Rates and Absolute PPPs Using CPI Data 8.8Explaining the Failure of Absolute PPP 8.9Comparing Incomes Across Countries 8.10Relative Purchasing Power Parity 8.11 The Real Exchange Rate

3 8.1Price Level and Price Indexes Price Level and Price Indexes: Overview The General Idea of Purchasing Power Calculating the Price Level Calculating a Price Index

4 8.1Price Level and Price Indexes The General Idea of Purchasing Power Nominal price Price level Inflation/Deflation

5 8.1Price Level and Price Indexes The General Idea of Purchasing Power Nominal price Price level Inflation/Deflation Calculating the Price Level Calculating a Price Index Price index

6 8.1Price Level and Price Indexes Calculating the Price Level Calculating a Price Index

7 Exhibit 8.1 Price Indexes for the G7 Countries,

8 8.2The Purchasing Power of a Currency A Currency’s Purchasing Power: Overview Internal Purchasing Power External Purchasing Power

9 8.2The Purchasing Power of a Currency Internal Purchasing Power The power of the dollar when it is used within the United States to purchase goods and services The internal power of one dollar at time t is

10 8.2The Purchasing Power of a Currency External Purchasing Power The power of the U.S. dollar when it is used to purchase good and services outside of the United States The external power of one dollar at time t is

11 8.3Absolute Purchasing Power Parity Absolute Purchasing Power Parity States that the exchange rate adjusts to equalize the internal with external purchasing powers of a currency.

12 8.3Absolute Purchasing Power Parity A good market arbitrage Suppose the US price level is $15,000/ consumption bundle, and the UK price level is £10, 000. The exchange rate is $1.4/ £. The internal purchase power of $ 1 million in US is $ / $15,000 = consumption bundles The external purchase power of $ 1 million in UK is $ / $1.4/ £= £ £ / £ = consumption bundles

13 8.4The Law of One Price The Law of One Price: Overview The Perfect Market Ideal Why Violations of the Law of One Price Occur

14 8.4The Law of One Price The Perfect Market Ideal The law of one price: The price of a commodity, when denominated in a particular currency, is the same wherever in the world it is sold when denominated in another currency.

15 8.4The Law of One Price Why Violations of the Law of One Price Occur Tariffs and quotas Transaction costs that prevent trade Speculation Noncompetitive markets Pricing to market Sticky prices menu costs

16 8.5Describing Deviations from PPP Deviations from PPP: Overview Overvaluations and Undervaluations of Currencies Predictions Based On Overvaluations and Undervaluations

17 8.5Describing Deviations from PPP Overvaluations and Undervaluations of Currencies Currency overvalued when its external purchasing power exceeds its internal purchasing power Currency undervalued when its external purchasing power is less than its internal purchasing power

18 8.5Describing Deviations from PPP Predictions Based On Overvaluations and Undervaluations Overvaluations Undervaluations

19 8.6The MacPPP Standard The MacPPP Standard: Overview The Big Mac as a Price Index Comparing Prices Across Countries Some Predictions of Currency Appreciations

20 8.6The MacPPP Standard The Big Mac as a Price Index Advantages to use: Standard product globally Local suppliers used reducing transit costs

21 8.6The MacPPP Standard Comparing Prices Across Countries  Local Currency and Dollar Prices  Implied PPP Exchange Rates  Overvaluations and Undervaluations

22 Exhibit 8.2 MacPPP in 2006

23 8.6The MacPPP Standard Some Predictions of Currency Appreciations  Predicting British Heartburn PPP: DEM 2.58/£ European exchange rate mechanism (ERM): : DEM 2.95/£ Soros  Predicting Initial Weakness of the Euro  The Econometric Evidence

Exchange Rates and Absolute PPPs Using CPI Date Interpreting the Charts  Overvaluations and Undervaluations  Fixing When PPP Held

Exchange Rates and Absolute PPPs Using CPI Date Dollar-Pound Data  Exhibit 8.3

26 Exhibit 8.3 Actual USD/GBP and PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date Deutsche Mark-Dollar Data  Exhibit 8.4

28 Exhibit 8.4 Actual DEM/USD and PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date Yen-Dollar Data  Exhibit 8.5

30 Exhibit 8.5 Actual JPY/USD and PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date Canadian Dollar-U.S. Dollar Data  Exhibit 8.6

32 Exhibit 8.6 Actual CAD/USD and PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date French Franc-Deutsche Mark Data  Exhibit 8.7

34 Exhibit 8.7 Actual FRF/DEM and Implied PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date Italian Lira-Deutsche Mark Data  Exhibit 8.8

36 Exhibit 8.8 Actual ITL/DEM and PPP Exchange Rates

Exchange Rates and Absolute PPPs Using CPI Date Mexican Peso-Dollar Data  Exhibit 8.9

38 Exhibit 8.9 Actual MXP/USD and PPP Exchange Rates

39 8.8Explaining the Failure of Absolute PPP The Failure of Absolute PPP: Overview Changes in Relative Prices Non-Traded Goods - haircut - house PPP Deviations and the Balance of Payments

40 8.8Explaining the Failure of Absolute PPP Changes in Relative Prices

41 8.8Explaining the Failure of Absolute PPP Non-Traded Goods  Housing  Technological Change PPP Deviations and the Balance of Payments

42 8.9Comparing Incomes Across Countries Comparing Incomes Across Countries: Overview Comparing Incomes in New York and Tokyo Comparing GDPs Using PPP Exchange Rates

43 8.9Comparing Incomes Across Countries Comparing Incomes in New York and Tokyo Incorporating purchasing power Working with the PPP rate

44 8.9Comparing Incomes Across Countries Comparing GDPs Using PPP Exchange Rates

45 Exhibit 8.10 GDP per Capita for OECD Countries in 2006 Using Exchange Rates and PPP Values

Relative Purchasing Power Parity Relative Purchasing Power: Overview Introduction A General Expression for Relative PPP 假定的放松 (1) 存在交易成本 (2) 各国一般价格水平的计算中商品及其相应的权重存在 差异，因此，各国一般价格水平以同一种货币计算时 并不完全相等，而是存在一定的较为稳定的偏差；

Relative Purchasing Power Parity Introduction Relative purchasing power parity: Exchange rates adjust in response differences in inflation rates across countries leaving the differences in purchasing power unchanged

Relative Purchasing Power Parity 存在交易成本： P t = Ke t P t * (1) K 为常数， K=1 时不存在交易成本，一价定价成立； K>1 或 K<1 时，一价定律不成立 P t+1 = Ke t+1 P t+1 * (2)

Relative Purchasing Power Parity A General Expression for Relative PPP The logic of relative PPP A symbolic representation of relative PPP

Relative Purchasing Power Parity Introduction Relative purchasing power parity A General Expression for Relative PPP The logic of relative PPP A symbolic representation of relative PPP Relative PPP with Continuously Compounded Rates of Change (Advanced)

The Real Exchange Rate The Real Exchange Rate: Overview The Definition of the Real Exchange Rate Real Appreciations and Real Depreciations Trade-Weighted Real Exchange Rates

The Real Exchange Rate The Definition of the Real Exchange Rate A nominal exchange rate that is adjusted by the ratio of the price levels in two countries

The Real Exchange Rate Real Exchange Rate and PPP - Absolute PPP hold: - Relative PPP hold:

The Real Exchange Rate Real Appreciations and Real Depreciations The percentage change in the real exchange rate What leads to real appreciations or depreciations

The Real Exchange Rate Trade-Weighted Real Exchange Rates: An average of all the bilateral real exchange rates of a country using the relative amount of trade between countries as weights where, w i is the proportion of trade conducted with country i

56 Exhibit 8.11 Actual ARS/USD and PPP Exchange Rates