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Purchasing power

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The logarithm of the purchasing power ratio (PPR) is shown for seven countries and three alternative price indices to follow a stationary and invertible process in the first differences. This means that permanent shifts in the parity value accumulate over time. Therefore, as the prediction interval lengthens, the variance of the level of the PPR goes towards infinity while the variance of its average growth rate goes to zero. Since the variance of the permanent shifts is substantial: (1) Harmonized money growth cannot maintain constant exchange rates; reserve flows feedback is required. (2) Economic explanations of the permanent shifts are an important research topic.

Purchasing power.

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Purchasing power parity --- Purchasing power parity

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Money. --- Purchasing power.

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The paper is a survey of PPP theory and evidence prepared for the New Palgrave dictionary of economics. Following a statement of the absolute and relative versions of the theory, there is a brief sketch of the history of thought with emphasis on Cassel and the monetary approach. A theoretical part distinguishes structural and transitory deviations from PPP. The main basis for structural deviations is the Ricardo-Harrod-Balassa-Samuelson model of productivity differentials that affect the real prices of home goods and hence real price levels. Transitory deviations emerge from differential speeds of goods and assets markets. In particular sticky wages combined with imperfect competition or spatial discrimination in pricing give rise to sometimes persistent movements in real exchange rates. After an overview of empirical evidence the paper concludes with a review of implications of PPP disparities. Applications to international real income comparisons, interest rate linkages and exchange rate policy receive attention.

Purchasing power parity.