Parity Exchange Rates Research Articles

Alternative measures of output in global economic–environmental models: Purchasing power parity or market exchange rates? — Comment

Nordhaus [Nordhaus, W. 2006, Alternative measures of output in global economic–environmental models: purchasing power parity or market exchange rates? Energy Economics, doi 10.1016/j.eneco.2006.02.003] examines the question of the use of purchasing power parity versus market exchange rates in constructing global economic models. He concludes that the best approach is to use PPP measures for relative incomes and outputs and national accounts' prices and quantity indexes for time series extrapolations. In this comment we argue and show that international real income comparisons based on PPP measures overstate the real incomes of poorer countries and underestimate the real incomes of richer regions. This is the case because the PPP approach fails to account for the differences in various non-traded attributes, such as availability of public goods and the location, attached to the final sale of the goods being compared. Additionally, using a teleporting consumer model we show that the use of real exchange rates to convert real quantities and the use of market exchange rates to convert nominal incomes preserve real income rankings across nations and this approach is consistent with standard economic theory.

A Contribution to the "Purchasing Power Parity vs. Market Exchange Rates for Use in Long-Term Scenarios" Discussion

A Contribution to the "Purchasing Power Parity vs. Market Exchange Rates for Use in Long-Term Scenarios" Discussion

China's Exchange Rate Trap: Japan Redux?

Today’s American mercantile pressure on China to appreciate the renminbi against the dollar is eerily similar to the American pressure on Japan to appreciate the yen that began over 30 years ago. Indeed, the yen went all the way from 360 to the dollar in August 1971, at the end of the Bretton Woods period of fixed exchange rate parities, to touch 80 to the dollar in April 1995. Then the American government relented and announced a strong dollar policy that signaled the end of “Japan bashing”. But the overvalued yen, and the expectation of appreciation, destabilized the Japanese financial system; the bubble economy of the late 1980s was followed by a deflationary slump and a zero-interest liquidity trap in the 1990s [McKinnon and Ohno 1997]. At least some of today’s critics of East Asian countries’ pegging to the dollar would agree that international saving imbalances rather than misaligned exchange rates are the root cause of the U.S. current-account deficit. One can argue whether it is mainly a saving deficiency in the United States or a saving glut in the rest of the world [Bernanke 2005]. Either way, the central position of the United States under the world dollar standard gives it alone an unlimited international line of credit in its own currency. However, suppose that the U.S. trade deficit is misdiagnosed to result from a misaligned exchange rate, so that a surplus country on the dollar’s periphery is forced to appreciate against the world’s dominant money. It will suffer a slowdown in economic

Alternative measures of output in global economic-environmental models: Purchasing power parity or market exchange rates?

The study examines the question of the use of purchasing power parity versus market exchange rates in constructing global economic models. It compares three approaches: MER accounts, world-price PPP accounts, and superlative PPP accounts. It concludes that the best approach is to use superlative PPP accounts. This approach uses cross-sectional PPP measures for relative incomes and outputs and relies on national accounts price and quantity indexes for time-series extrapolations. Under ideal circumstances, this approach will provide accurate and consistent cross-sections and time series. This approach will require relatively little change in model structure from ones using MER accounts. The main concern would be to ensure that behavioral and reduced-form relationships in the models have been correctly estimated.

A Model for a Fair Exchange Rate

Financial markets have developed formulas and models to derive fair values for bonds, futures, swaps, options and other securities. This model derives a fair value of an exchange rate, which might be used as a benchmark for a long-term equilibrium level to stabilize currency markets. The model is based on the value-added tax adjusted purchasing power parity exchange rate. This rate is then modified by five components: the macro-economic component, the foreign currency reserve component, the debt component, the interest rate component, and the political stability/leadership component. With respect to the American dollar, the model shows that the Euro and the Japanese Yen are overvalued compared to its current exchange rate, while the Brazilian Real, the Russian Ruble, the Chinese Yuan and the Australian dollar are currently undervalued.

Purchasing Power Parity and real exchange rate behaviour in Africa

African policy makers have being implementing exchange rate policy reforms based on the assumption that long-run PPP holds in Africa. This study conducted a detailed empirical investigation to ascertain whether or not there is empirical support for long-run PPP in African countries. Because of the significant black market premium, we applied Johansen's cointegration method to annual data on official and black market exchange rates, and the GDP deflators of 40 countries covering the 1958–2003 period. The research shows overwhelming support for long-run PPP in Africa, thus, PPP is a reliable guide for exchange rate determination and exchange rate policy reform in African countries.

Analysing Convergence with a Multi-Country Computable General Equilibrium Model: PPP versus Mer

In studies of the greenhouse gas implications of convergence by developing countries to the per-capita GNPs of developed countries, considerable discussion has centred on whether purchasing power parity (PPP) or market exchange rates (MER) should be used in measuring per-capita GNPs. We suggest that technology gaps between developing and developed countries should be the starting point for convergence analysis rather than per-capita GNP gaps. We estimate two sets of initial technology gaps, using PPP and MER price assumptions combined with input-output data. In simulating the effects of closing technology gaps (convergence) using a dynamic, multi-country CGE model, we find: the MER/PPP distinction matters. MER-based estimates of initial technology gaps lead to higher estimates of convergence-induced growth in greenhouse-gas-emitting industries in developing countries than do PPP-based estimates. the industry detail in CGE models is valuable. Our simulations show a wide range of convergence-induced changes in output across industries.

Valuing the Arsenic Contamination of Groundwater in Bangladesh

The use of groundwater in Bangladesh has in the past been promoted as a means of avoiding waterborne diseases associated with the consumption of untreated surface water. Unfortunately, the recent discovery of high levels of naturally occurring arsenic in groundwater in Bangladesh used for drinking purposes has led one international agency to describe the situation as a major public health emergency. Arsenic ingestion is associated with an elevated risk of various cancers. Epidemiological dose–response functions combined with survey estimates of arsenic concentrations in groundwater, and the number of households in Bangladesh relying on groundwater for drinking are used to derive an estimate of annual mortality and morbidity cases attributable to arsenic contamination. The estimated health impacts include 6500 fatal cancers and 2000 non-fatal cancers. Aggregate willingness to pay to avoid these health impacts is estimated to be $2.7 billion annually using purchasing power parity exchange rates. The methodology and results presented in this paper may have application to other countries.

Denomination composition of trade and trade balance: evidence from Turkey

The currency denominations of a country's exports and imports are not necessarily the same. If this is the case, then a change in the exchange rate parity among major currencies will affect the trade balance. The empirical evidence provided from Turkey – where exports are mostly denominated in Euros and imports are mostly denominated in USD – suggests that an appreciation of the Euro against the USD would increase the output in the long-run, appreciate the local currency and improve the trade balance for the 1985:01 2003:07 period.

Comment and Discussion

Comment and Discussion Arvind Panagariya General Discussion References Bhagwati, Jagdish. 1984. "Splintering and Disembodiment of Services and Developing Nations." World Economy 7: 133-44. Bhagwati, Jagdish, and Padma Desai. 1970. India: Planning for Industrialization. Oxford University Press. Bhagwati, Jagdish, and T. N. Srinivasan. 1975. India. Vol. 6. New York: National Bureau of Economic Research / Columbia University Press. Bhagwati, Jagdish, Arvind Panagariya, and T. N. Srinivasan. 2004. "The Muddles about Outsourcing." Journal of Economic Perspectives 18 (Fall): 93-114. D'Costa, Anthony P. 2003. "Uneven and Combined Development: Understanding India's Software Exports." World Development 31 (1): 211-26. Dossani, Rafiq. 2002a. "Chinese and Indian Engineers and Their Networks in Silicon Valley. "Working Paper. Stanford University, Asia-Pacific Research Center (March). ———. 2002b. Telecommunications Reform in India. Westport, Conn.: Greenwood Press. ———. 2004. "The Software Industry in India." Working Paper. Stanford University. Dossani, Rafiq, and Martin Kenney. 2004. "Lift and Shift: Moving the Back-office to India." Information Technology and International Development 1 (2): 21-37. Dossani, Rafiq, and Anita Manwani. 2005. "Agilent's Supply Chain: A Locational Analysis of Its Indian Operations." Paper presented at the Conference on Globalization of Services, Stanford University, June. Gadfrey, J., and F. Gallouj. 1998. "The Provider-Customer Interface in Business and Professional Services. Service Industries Journal 18 (2): 1-15. Gereffi, Gary, John Humphrey, Raphael Kaplinsky, and Timothy J. Sturgeon. 2001. "Introduction: Globalisation, Value Chains and Development." IDS Bulletin 32 (3) July: 1-8. Goodman, Bill, and Reid Steadman. 2002. "Services: Business Demand Rivals Consumer Demand in Driving Job Growth." Monthly Labor Review 125 (4): 3-16. Hobday, Michael. 1995. Innovation in East Asia: The Challenge to Japan. Cheltenham: Edward Elgar. Humphrey, John. 2004. "Upgrading in Global Value Chains." Working Paper 28. Geneva: World Commission on the Social Dimension of Globalization, International Labor Organization. Indian Economic Survey. 2004. New Delhi: Ministry of Finance. Indian National Commission for Cooperation with UNESCO. 1998. "Higher Education in India: Vision and Action Country Paper." Paper presented at the UNESCO World Conference on Higher Education in the 21st Century, Paris, October 5-9. Available at www.education.nic.in/htmlweb/unhighedu.htm. NASSCOM 2002. The IT Industry in India. New Delhi. ———. 2004. The IT Industry in India. New Delhi. Panagariya, Arvind. 2001. "The Indian Diaspora in the United States." Economic Times. May 23. [End Page 276] ———. 2004. "Why the Recent Samuelson Article Is NOT about Offshore Outsourcing." Columbia University. Available at www.columbia.edu/~ap2231/. Parthasarathi, Ashok, and K. J. Joseph. 2002. "Limits to Innovation with Strong Export Orientation: The Case of the Indian Information Communication Technology Sector." Science, Technology and Society 7 (1): 13-50. Samuelson, Paul A. 2004. "Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization." Journal of Economic Perspectives 18 (3): 135-46. Sampson, Gary P., and Richard Snape. 1985. "Identifying the Issues in Trade in Services." World Economy 8: 171-81. Scholte, Jan A. 2000. Globalization: A Critical Introduction. New York: Palgrave Macmillan. Schware, Robert. 1992. "Software Industry Entry Strategies for Developing Countries: A "Walking on Two Legs" Proposition." World Development 20 (2): 143-64. Singh, Manmohan. 1964. India's Export Trends. Oxford: Clarendon Press. Statistical Outline of India. 2001-2002. Mumbai: Tata Services. Thompson, Paul, Chris Warhurst, and George Callaghan. 2001. "Ignorant Theory and Knowledgeable Workers: Interrogating the Connections between Knowledge, Skills and Services." Journal of Management Studies 38 (7): 923-42. U.S. Government Accountability Office (GAO). 2004. "Current Data Provide Limited Insight into Offshoring of Services." September. Vernon, Raymond. 1966. "International Investment and International Trade in Product Cycle." Quarterly Journal of Economics 80 (2): 190-207. Whitman, J. 1990. "Key Factors for Software Success." Mimeo (Cambridge, Mass.: Oakland Group, December 26). World Development Indicators. 1999. Washington: World Bank. Wortzel, L. H., and H. V. Wortzel. 1981. "Export Marketing Strategies for NIC and LDC-Based Firms." Columbia Journal of World Business 16 (1): 51-60. Yotopoulos, Pan A. 1996. Exchange Rate Parity for Trade and Development: Theory, Tests and Case Studies. Cambridge University Press. [End Page 277] Copyright © 2005 The Brookings Institution

The Purchasing Power Parity Debate

Originally propounded by the sixteenth-century scholars of the University of Salamanca, the concept of purchasing power parity (PPP) was revived in the interwar period in the context of the debate concerning the appropriate level at which to re-establish international exchange rate parities. Broadly accepted as a long-run equilibrium condition in the post-war period, it was first advocated as a short-run equilibrium by many international economists in the first few years following the breakdown of the Bretton Woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s. Accordingly, over the last three decades, a large literature has built up that examines how much the data deviated from theory, and the fruits of this research have provided a deeper understanding of how well PPP applies in both the short run and the long run. Since the mid 1990s, larger datasets and nonlinear econometric methods, in particular, have improved estimation. As deviations narrowed between real exchange rates and PPP, so did the gap narrow between theory and data, and some degree of confidence in long-run PPP began to emerge again. In this respect, the idea of long-run PPP now enjoys perhaps its strongest support in more than thirty years, a distinct reversion in economic thought. Our willingness to pay a certain price for foreign money must ultimately and essentially be due to the fact that this money possesses a purchasing power as against commodities and services in that country. On the other hand, when we offer so and so much of our own money, we are actually offering a purchasing power as against commodities and services in our own country. Our valuation of a foreign currency in terms of our own, therefore, mainly depends on the relative purchasing power of the two currencies in their respective countries.

Purchasing Power Parity Exchange Rates from Household Survey Data: India and Indonesia

Purchasing power parity (PPP) exchange rates are extensively used by researchers and by policymakers. This paper proposes and implements a new methodology for calculating PPPs using information on unit values from household surveys. Although unit values are not identical to prices, they have compensating advantages. Large household surveys contain several million unit values, they are tied to actual transactions, and they are naturally linked to household characteristics such as income. In consequence, it is possible to calculate PPPs for different social groups, including PPPs for the poor. The paper calculates multilateral price indexes for the states and sectors of India, as well as PPPs for rural and urban Indonesia together with rural and urban India. PPPs for the poor are distinguished from general PPPs. The internal PPPs for India are not very different from previous estimates based on bilateral comparisons, but the estimated PPP between India and Indonesia is very different from the numbers calculated by either the Penn World Table or the World Bank. It implies that either India is much better-off, or Indonesia much poorer (or both) than is generally supposed.

Can the IPCC SRES Be Improved?

* This is a substantially reduced version of a paper entitled “Long Run Projections for Climate Change Scenarios” that was presented at the Stanford Energy Modeling Forum workshop on Purchasing Power Parity versus Market Exchange Rates and is available as a Lowy Institute working paper at http://www.lowyinstitute.org/Publication.asp?pid=129. The original paper covers a wide range of issues whereas this extract focuses on the SRES. The paper has benefited from discussions with Peter Wilcoxen, Barry Bosworth, Ian Castles, Alan Heston, Neil Ferry and many colleagues at the Stanford meeting. The views expressed in the paper are those of the authors and should not be interpreted as reflecting the views of the Institutions with which the authors are affiliated including the trustees, officers or other staff of the Brookings Institution.

The Price of Gold: A Global Required Yield Theory

We construct a gold valuation theory based on viewing gold as a global real store of wealth. We show that the real price of gold varies inversely to the stock market P/E and thus is a direct function of a global yield required to achieve a constant real after-tax return equal to long-term global real GDP per-capita growth. We introduce a new exchange rate parity rule based on the equalization of inverse stock market P/Es (required yields) across nations. Foreign exchange affects the price of gold to the extent that required yields and Purchasing Power Parity equalizations do not take place across nations in the short run. A quarterly valuation model is constructed using concurrent economic data that is within 12% mean percentage tracking error from real U.S. gold prices from 1979- 2002. Several major world events have had a large but fleeting impact on gold prices.

How to Monitor Poverty for the Millennium Development Goals

I consider two issues concerning how to monitor global poverty for the Millennium Development Goals, the selection of poverty lines, and the data sources for monitoring poverty over time. I discuss the choice of a single international line, converted using purchasing power parity (PPP) exchange rates, versus the use of country- specific poverty lines. I note the difficulties in constructing PPP exchange rates but argue in favor of a single international line, converted at PPP rates, which would be regularly updated using domestic price indexes. Re-basing, using updated PPP rates, would be done infrequently. For example, if the global poverty numbers were estimated annually, the PPP rates might be updated once a decade. In any case, it is important that the poverty estimates be calculated much more frequently than the PPP rates are revised. I discuss whether monitoring should be performed using national accounts data on income or consumption, supplemented by distributional data so as to make inferences about poverty, or using data from household survey data. I argue that data from the national accounts are not suitable for measuring poverty and that their use requires assumptions that are unlikely to hold. In particular, monitoring poverty through the national accounts runs the risk of pre- judging important issues that are properly the subject of measurement, not assumption, such as the extent to which aggregate growth benefits the poor. I argue that poverty should be directly measured using household survey data, and I discuss what needs to be done to enable such monitoring to be placed on a sounder basis.

Purchasing Power Parity

AbstractThe paper provides a selective and critical review of the literature on purchasing power parity and real exchange rates, with special reference to the literature of the last two decades.

How to Monitor Poverty for the Millennium Development Goals

I consider two issues concerning how to monitor global poverty for the Millennium Development Goals, the selection of poverty lines, and the data sources for monitoring poverty over time. I discuss the choice of a single international line, converted using purchasing power parity exchange rates, versus the use of country-specific poverty lines. I note the difficulties in constructing purchasing power parity exchange rates but argue in favor of a single international line, converted at PPP rates, but which would be regularly updated using domestic price indexes. Re-basing, using updated PPP rates, would be done infrequently. For example, if the global poverty numbers were estimated annually, the PPP rates might be updated once a decade. In any case, it is important that the poverty estimates be calculated much more frequently than the PPP rates are revised. I discuss whether monitoring should be done using national accounts data on income or consumption, supplemented by distributional data so as to make inferences about poverty, or from household survey data. I argue that data from the national accounts are not suitable for measuring poverty and that their use requires assumptions that are unlikely to hold. In particular, monitoring poverty through the national accounts runs the risk of prejudging important issues that are properly the subject of measurement, not assumption, such as the extent to which aggregate growth benefits the poor. I argue that poverty should be directly measured using household survey data, and discuss what needs to be done to enable such monitoring to be placed on a sounder basis.

Counting the World's Poor: Problems and Possible Solutions

The World Bank prepares and publishes estimates of the number of poor people in the world. These numbers, particularly the count of people living below $1 a day, are widely quoted and used by the Bank, the press, and by political leaders around the world. They are the raw material in the debate on whether or not world growth reduces world poverty. This paper discusses how the poverty estimates are constructed, and asks whether they can bear the burden placed on them. One specific difficulty is the use of purchasing power parity (PPP) exchange rates, whose revision induces large changes in poverty estimates for the same countries in the same years. Another area of dispute is the discrepancy in many countries between national accounts statistics, which are used to compute growth rates, and survey estimates, which are used to compute poverty estimates. To a considerable extent, the failure of world poverty to fall in the face of world growth is a failure of household survey data to be consistent with national income data. The details of survey design are also important. In India, changing the reference period for reporting consumption removes around 200 million people, a sixth of the world total, if not from poverty, at least from the poverty counts.

What Do We Know About Recent Exchange Rate Models? In-Sample Fit and Out-Sample Performance Evaluated

Previous assessments of nominal exchange determination have focused upon a narrow set of models typically of the 1970's vintage, including monetary and portfolio balance models. In this paper we re-assess the in-sample fit and out-of-sample prediction of a wider set of models that have been proposed in the last decade, namely interest parity, productivitybased models, and behavioral equilibrium exchange rate models. These models are compared against a benchmark model, the Dornbusch-Frankel sticky price monetary model. First, the parameter estimates of the models are compared against the theoretically predicted values. Second, we conduct an extensive out-of-sample forecasting exercise, using the last eight years of data to determine whether our in-sample conclusions hold up. We examine model performance at various forecast horizons (1 quarter, 4 quarters, 20 quarters) using differing metrics (mean squared error, direction of change), as well as the consistency test of Cheung and Chinn (1998). We find that no model fits the data particularly well, nor does any model consistently out-predict a random walk, even at long horizons. There is little correspondence between how well a model conforms to theoretical priors and how well the model performs in a prediction context. However, we do confirm previous findings that outperformance of a random walk is more likely at long horizons.

The World Economy

Global economic activity strengthened considerably in the first half of this year, helped by a rebound in trade volumes and a marked recovery in industrial production. Although the rapid growth experienced in the early part of the year has faltered, there was still broadly-based, if somewhat subdued, growth in activity in all the major economies in the second quarter of the year, with GDP rising by between 0.3-0.6 per cent in the US, the UK, the Euro Area and Japan. For the year as a whole we continue to expect global GDP growth (measured at Purchasing Power Parity exchange rates) to be around 2¾ per cent, which whilst below long-term trend levels, would be a welcome improvement on the growth of under 2¼ per cent seen in 2001.