Purchasing power parity
Purchasing power parity ( PPP or KKB = purchasing power adjusted; English purchasing power parity , PPP ; parity = equality from Latin par 'equal') is a term from macroeconomics . Purchasing power parity between two geographic areas in the same currency area exists when goods and services in a basket of goods can be purchased for the same amount of money. If two different currency areas are compared, the amounts of money are made comparable using exchange rates . In this case, purchasing power parity prevails if the different currencies have the same purchasing power due to the exchange rates and you can therefore buy the same shopping basket. If there is purchasing power parity between two countries, the real exchange rate is one. Purchasing Power Parity (PPP) is the macroeconomic counterpart to the microeconomic law of indifference in prices .
The concept of purchasing power parity is used for a number of applications:
- As a long-term exchange rate theory ( purchasing power parity theory ): Accordingly, exchange rates or inflation adjust so that purchasing power parity prevails between the two currency areas. The exchange rate at which purchasing power is the same in both currency areas is called the purchasing power parity exchange rate;
- As a correction factor: In order to make economic variables such as gross domestic product , gross national income , per capita income or absolute poverty internationally comparable, a mere conversion using current exchange rates is not sufficient, since purchasing power can vary greatly in different currency areas. Typical concepts here are the purchasing power standard ( PPS ) and the PPP US dollar ( PPP $ ). Here, however, no statement is made about economic strength, but rather the level of activity and the level of prosperity of the national economies compared, since the values calculated using PPS are fictitious.
Purchasing power parity theory
The purchasing power parity theory states that the exchange rates between two currencies fluctuate mainly to compensate for price level differences. It is based on the principle of the law of the single price . Accordingly, a good should sell for the same price all over the world. Otherwise there would be arbitrage opportunities . According to this theory, a monetary unit must have the same purchasing power in all countries , it must have the same real value everywhere. This is also called absolute purchasing power parity .
The purchasing power parity theory originally stems from monetary foreign trade theory . It is calculated how many units of the respective currency are necessary to buy the same representative basket of goods that one could get for 1 US dollar in the USA. In the short term, the exchange rate can deviate from purchasing power parity, especially since monetary disruptions can cause rapid changes in the exchange rate, while the price level changes relatively slowly. In the long term, however, it should fluctuate around this value. This is then called relative purchasing power parity .
Gustav Cassel is considered to be the pioneer of the purchasing power parity theory , although approaches to it can already be found in the 17th century. Based on this interpretation and the interest parity theory , Rudiger Dornbusch developed the monetary exchange rate theory .
The purchasing power parity theory is a simplified representation of the principle of how exchange rates are constituted. It does not include the transaction costs actually incurred in practice (transport costs, customs and tax duties, as well as distortions due to government trade restrictions). Since the theory is based on Jevons law , the same conditions must apply. However, this rarely occurs in reality.
Dornbusch and Fischer show empirically, using the example of the exchange rate of the DM and the US dollar since 1979, that the theory cannot be applied linearly in every case.
Another point of criticism is the (minor) influence that the buying and selling of foreign currency from commodity transactions have on exchange rate developments today. According to the latest foreign exchange statistics from 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) US dollars, an increase of 70% since the last survey in 2004. According to this, only about three percent of sales come from goods transactions.
Purchasing power parities as a correction factor
For international income comparisons, international organizations (e.g. World Bank ) determine such purchasing power parities empirically in order to eliminate distortions due to exchange rate fluctuations. The World Bank uses the term local purchasing power for its definition of poverty. In order to be able to compare people's incomes , the purchasing power of the US dollar is converted into local purchasing power.
Since many developing countries have undervalued currencies (according to the purchasing power parity theory), their per capita income in (USD) purchasing power parities is mostly higher than converted using official exchange rates.
A popular example of purchasing power parities on an alternative basis is the Big Mac index , published regularly by The Economist magazine . It determines how much a Big Mac costs in a McDonald’s restaurant in different countries around the world. These prices are made the basis of a currency conversion. The iPod index is similar. The sales price of the iPod produced by Apple is compared in different countries. A main difference between the two indices is that iPods represent a commodity that can be traded across national borders, while Big Macs do not trade internationally, which is why Big Macs cannot lead to offsetting arbitrage deals. The UBS compares some years Big Mac, bread, iPhones and more. However, it is not only focused on the price, but rather shows how many hours employees have to work in different cities and countries in order to be able to afford product X.
Purchasing power comparison based on EuroStat data in the time series
|1.||EU (28 countries)||100||100||100||100||100||100||100||100||100||100||100||100||100|
|2.||EU (27 countries)||100||100||100||100||100||100||100||100||100||100||100||100||100|
|3.||Euro area (19 countries)||109||109||109||109||108||108||107||107||107||106||106||106||106|
|5.||Euro area (18 countries)||110||110||109||109||108||108||108||107||107||107||107||107||106|
|35.||Liechtenstein||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A||:n / A|
|43.||Bosnia and Herzegovina||26th||28||29||30th||29||30th||30th||30th||30th||30th||31||32||31|
Source: EuroStat, data from June 1, 2018.
Example table for arbitrage possibilities based on example values
|country||GDP / capita (in USD)||GDP / capita (in PPP- $)||relation|
In 1997, about 1.43 Swiss francs had to be paid for one US dollar . 1.43 divided by 0.62 (see table) gives 2.31; the purchasing power parity between the dollar and the franc was accordingly 2.31. This means that in the year in question in Switzerland, at 2.31 francs, the same amount of goods could be purchased as in the USA with 1 US dollar.
According to the purchasing power parity theory, the Swiss franc would be overvalued against the US dollar because there would be an arbitrage opportunity. You could exchange francs for dollars so that you could buy goods in the USA and sell them at a profit in Switzerland. As a result, francs would be constantly exchanged for dollars, and the franc would lose value. Only if the Swiss franc had depreciated against the US dollar to 62% of its original value would this possibility no longer exist and arbitrage would no longer be worthwhile.
International Comparison Program
The international comparison project (ICP) tries to make the economic performance of national economies more comparable. A real comparison is often difficult as the freely formed exchange rates are often distorted (e.g. China's foreign exchange interventions). Therefore, the ICP considers the price development of shopping baskets according to the purchasing power parity approach in order to enable a more realistic investigation.
Price system choice & Samuelson effect
The choice of a suitable price system proves to be difficult, because despite the same economic performance - due to different price levels - countries appear to be performing differently. This distortion effect is also called the Balassa-Samuelson effect . The ICP chooses an average price system to reduce the Gerschenkrone effect.
The international prices ( average price system ) are defined as:
Conversely, this results in the purchasing power parity of country j:
Explanation of the symbols:
- - international price for good i
- - Price for good i in country j
- - purchasing power parity of country j
- - amount of good i produced in country j
- - World production of goods i
Compared to the conventional calculation using exchange rates:
- The gap between the countries is smaller
- Service quota (expenditure on services based on national product) is similar in developing and industrialized countries (approx. 1/3 each)
- The investment rate (investment expenditure measured against the national product) is much higher in industrialized countries
Criticism & Problems
- statistical data collection
- Find a comparable product in order to be able to collect and collect (especially difficult for services)
- Gerschenkron effect occurs despite the average price system
- In the equation for determining international prices, a country's share of world production is heavily weighted:
- ⇒ Distortion of international prices in favor of countries with a higher share of global production
- ICP is based on the purchasing power parity approach, which presupposes free trade (law of the uniform price). However, this is only the case between some nations.
- Reinhard Gerhold: Purchasing power parity as a link between real and monetary foreign trade theory , Metropolis , Marburg 1999.
- Maurice Obstfeld , Kenneth S. Rogoff : Foundations of international macroeconomics , 7th edition, Cambridge / MA 2004.
- Nicholas Mankiw : Fundamentals of Economics , 3rd edition Schäffer Poeschel, 2004.
- Irving B. Kravis: Comparative Studies of National Incomes and Prices, Journal of Economic Literature , American Economic Association, Volume 22 (1), pp. 1-39; March 1984.
- Penn World Table - Comprehensive collection of statistical data from the last few decades
- International comparison of consumer prices. Technical series 17 series 10. destatis , accessed on June 14, 2013 .
- Purchasing power parities. destatis , accessed February 2, 2015 .
- Prices and wages around the world - UBS purchasing power comparison (PDF; 1.4 MB)
- Branko Milanovic : How statistics are changing the world economy , article by a World Bank economist on the effects of a comprehensive data revision on purchasing power parity from December 2007
- World Bank - "The 2005 International Comparison Program - Results"
- OECD : Prices and Purchasing Power Parities (PPP)
- List of countries according to purchasing power parity since 1990 ( World Bank )
- Rüdiger Dornbusch , Stanley Fischer : Makroökonomik , 6th edition, 1995, R. Oldenbourg Verlag, Munich, ISBN 3-486-22800-5 , pp. 760-761
- Triennial Central Bank Survey of the Bank for International Settlements
- UBS purchasing power comparison: Zurich and Geneva are among the most expensive cities , 2015. NZZ on September 17, 2015, accessed on December 1, 2015
- GDP per capita in PPS. In: EuroStat. Data from June 1, 2018. At ec.Europa.eu, accessed October 25, 2019.
- Fischer World Almanac 2000