Extensions of Purchasing Power Parity
This chapter extends the connection between goods prices and foreign exchange (FX) rates. First, we cover how inflation rates affect intrinsic FX rates. We’ll apply this idea to understand how FX misvaluations occur when FX rates are fixed. Second, we cover an adjusted version of absolute purchasing power parity (APPP), based on an economy’s per-capita gross domestic product (GDP).
Relative Purchasing Power Parity
There is an extension of the international law of one price (ILOP) and APPP conditions that has to do with FX rate movements over time. This dynamic version of the theory relates FX rate changes to relative inflation rates, where “inflation rate” refers to the percentage change in goods ...
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