Download Internal Purchasing Power

Chapter 8: Purchasing Power Parity and
Real Exchange Rates
熊家财
江西财经大学会计学院
[email protected]
1
Chapter 8: Purchasing Power Parity and
Real Exchange Rates
8.1
Price Level and Price Indexes
8.2
The Purchasing Power of a Currency
8.3
Absolute Purchasing Power Parity
8.4
The Law of One Price
8.5
Describing Deviations from PPP
8.6
The MacPPP Standard
8.7
Exchange Rates and Absolute PPPs Using CPI Data
8.8
Explaining the Failure of Absolute PPP
8.9
Comparing Incomes Across Countries
8.10
Relative Purchasing Power Parity
8.11
The Real Exchange Rate
2
8.1 Price Level and Price Indexes
Price Level and Price Indexes: Overview
• The General Idea of Purchasing Power
• Calculating the Price Level
• Calculating a Price Index
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8.1 Price Level and Price Indexes
• The General Idea of Purchasing Power
• Nominal price
• Price level
• Inflation/Deflation
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8.1 Price 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
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8.1 Price Level and Price Indexes
• Calculating the Price Level
P  t , $    wi P  t , i, $ 
N
i 1
•
Calculating a Price Index
 wi P  t  k , i, $ 
P t  k, $ 
PI  t  k , $  
100  i1 N
100
P t, $ 
 wi P  t , i, $ 
N
i 1
6
Exhibit 8.1
Price Indexes for the G7 Countries, 1960-2005
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8.2 The Purchasing Power of a Currency
A Currency’s Purchasing Power: Overview
• Internal Purchasing Power
• External Purchasing Power
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8.2 The 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
1/ P  t , $ 
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8.2 The 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
1
1

S (t, $ £) P  t , £ 
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8.3 Absolute Purchasing Power Parity
Absolute Purchasing Power Parity

States that the exchange rate adjusts to equalize the internal with
external purchasing powers of a currency.
1
1
1
 PPP

P  t ,$  S (t, $ £) P  t , £ 
S
PPP
(t, $ £) 
P  t ,$ 
P t, £ 
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8.3 Absolute 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
$1 000 000 / $15,000 = 66.67 consumption bundles
The external purchase power of $ 1 million in UK is
$1 000 000 / $1.4/ £= £714 286
£714 286 / £714 286= 71.43 consumption bundles
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8.4 The Law of One Price
The Law of One Price: Overview
• The Perfect Market Ideal
• Why Violations of the Law of One Price Occur
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8.4 The Law of One Price
• The Perfect Market Ideal
• The law of one price:
• The price of a commodity, when denominated
in a particular currency, is the same wherever
in the world it is sold when denominated in
another currency.
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8.4 The Law of One Price
• Why Violations of the Law of One Price Occur
• Tariffs and quotas
• Transaction costs that prevent trade
• Speculation
• Noncompetitive markets
• Pricing to market
• Sticky prices
menu costs
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8.5 Describing Deviations from PPP
Deviations from PPP: Overview


Overvaluations and Undervaluations of Currencies
Predictions Based On Overvaluations and Undervaluations
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8.5 Describing Deviations from PPP

Overvaluations and Undervaluations of Currencies
Currency overvalued when its external purchasing power
exceeds its internal purchasing power
•
1
1
1
 PPP

P  t ,$  S (t, $ £) P  t , £ 
Currency undervalued when its external purchasing
power is less than its internal purchasing power
1
1
1
 PPP

P  t ,$  S (t, $ £) P  t , £ 
•
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8.5 Describing Deviations from PPP

Predictions Based On Overvaluations and
Undervaluations

Overvaluations
P  t ,$ 
1
1
1
PPP
 PPP

 S (t, $ £) 
 S PPP (t, $ £) 
P  t ,$  S (t, $ £) P  t , £ 
P t, £ 

Undervaluations
P  t ,$ 
1
1
1
PPP
 PPP

 S (t, $ £) 
 S PPP (t, $ £) 
P  t ,$  S (t, $ £) P  t , £ 
P t, £ 
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8.6 The MacPPP Standard
The MacPPP Standard: Overview



The Big Mac as a Price Index
Comparing Prices Across Countries
Some Predictions of Currency Appreciations
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8.6 The MacPPP Standard

The Big Mac as a Price Index
•
Advantages to use:


Standard product globally
Local suppliers used reducing transit costs
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8.6 The MacPPP Standard

Comparing Prices Across Countries



Local Currency and Dollar Prices
Implied PPP Exchange Rates
Overvaluations and Undervaluations
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Exhibit 8.2 MacPPP in 2006
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8.6 The 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
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Interpreting the Charts


Overvaluations and Undervaluations
Fixing When PPP Held
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Dollar-Pound Data

Exhibit 8.3
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Exhibit 8.3
Actual USD/GBP and PPP Exchange Rates
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Deutsche Mark-Dollar Data

Exhibit 8.4
27
Exhibit 8.4
Actual DEM/USD and PPP Exchange Rates
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Yen-Dollar Data

Exhibit 8.5
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Exhibit 8.5
Actual JPY/USD and PPP Exchange Rates
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Canadian Dollar-U.S. Dollar Data

Exhibit 8.6
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Exhibit 8.6
Actual CAD/USD and PPP Exchange Rates
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

French Franc-Deutsche Mark Data

Exhibit 8.7
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Exhibit 8.7
Actual FRF/DEM and Implied PPP Exchange Rates
34
8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Italian Lira-Deutsche Mark Data

Exhibit 8.8
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Exhibit 8.8
Actual ITL/DEM and PPP Exchange Rates
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8.7 Exchange Rates and Absolute PPPs
Using CPI Date

Mexican Peso-Dollar Data

Exhibit 8.9
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Exhibit 8.9
Actual MXP/USD and PPP Exchange Rates
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8.8 Explaining 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
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8.8 Explaining the Failure of Absolute PPP

Changes in Relative Prices
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8.8 Explaining the Failure of Absolute PPP

Non-Traded Goods
 Housing
 Technological Change

PPP Deviations and the Balance of Payments
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8.9 Comparing Incomes Across Countries
Comparing Incomes Across Countries:
Overview
• Comparing Incomes in New York and Tokyo
• Comparing GDPs Using PPP Exchange Rates
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8.9 Comparing Incomes Across Countries
• Comparing Incomes in New York and Tokyo
• Incorporating purchasing power
• Working with the PPP rate
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8.9 Comparing Incomes Across Countries
• Comparing GDPs Using PPP Exchange Rates
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Exhibit 8.10
GDP per Capita for
OECD Countries in 2006
Using Exchange Rates and
PPP Values
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8.10 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；
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8.10 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
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8.10 Relative Purchasing Power Parity
存在交易成本：
Pt= KetPt*
(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
Pt+1= Ket+1Pt+1*
(2)
Pt 1 et 1 Pt *1


 *
Pt
et Pt
et 1 1  
1 


e

e

t 1
t
et 1   *
1  *
et 1 Pt 1 Pt *1 Pt 1 Pt


 *  * *
et
Pt Pt
Pt 1 Pt

et 1 et 1   1   *

 

*
et et 1   1   *
et 1  et    *


et
1  *
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8.10 Relative Purchasing Power Parity
• A General Expression for Relative PPP
• The logic of relative PPP
• A symbolic representation of relative PPP
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8.10 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)
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8.11 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
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8.11 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
RS  t , S / €   S  t , S / €  *
P t, € 
P  t ,$ 
In general
P*
RS  S *
P
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8.11 The Real Exchange Rate
• Real Exchange Rate and PPP
- Absolute PPP hold:
P* P P*
RS  S *  * *  1
P P P
- Relative PPP hold:
St 1 Pt *1
RSt 1
Pt 1
St 1 Pt *1 Pt *



*
S
P
RSt
St Pt 1 Pr
t t
Pt
According to relative PPP :
Pt *1 Pt * 1   * St
RSt 1 St 1 Pt *1 Pt * St 1 St







1
Pt 1 Pr 1   St 1
RSt
St Pt 1 Pr
St St 1
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8.11 The Real Exchange Rate
• Real Appreciations and Real Depreciations
• The percentage change in the real exchange rate
• What leads to real appreciations or depreciations
P*
RS  S *  ln  RS   ln  S   ln  P *   ln  P 
P
Take differential with both hand
dln  RS   dln  S   dln  P *   dln  P 
dRS dS dP * dP

 * 
RS
S
P
P
dRS
dS
dP *
dP

 * 

RS
S
P
P
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8.11 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
Si Pi *
REER   wi RSi   wi
i 1
i 1
P
N
N
where, wi is the proportion of trade conducted with
country i
55
Exhibit 8.11
Actual ARS/USD and PPP Exchange Rates
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