Introduction
Purchasing Power Parity (PPP) is one of the most important theories for determining exchange rate in the international finance. PPP is coined by Gustav Cassel in 1918, and this concept had been discussed by various economists. PPP theory explains that the change in the exchange rate between two currencies should be equal to the national price level when converted in a common currency; hence, a unit of one currency of the country will have the equal purchasing power in a foreign country. PPP can hold for all types of goods, but in practical, PPP is more likely to hold for tradable goods than non-tradable goods. The law of one price (LOP) is the basic fundamental concept of PPP. The law of one price stated that the identical product should sell for the same price which says that in the absence of trade barriers and transactions costs across the countries once converted the prices to a common currency. There are differences between LOP and PPP, LOP applies to individual product whereas PPP applies to the general price level. Today, various economists’ debate over PPP does not hold in the short run, it only holds in the long run. While only few economists believe PPP holds continuously in the real world. Contrary to PPP does not hold in the real world, economists stated that different countries’ goods are not perfect substitutes and international arbitrage is not possible as non-traded goods and transportation costs.
Does PPP holds in the short run and long run?
A study by Taylor & Taylor (2004) used Producer Price Index and Consumer Price Index (CPI) between two countries US and UK to test whether two versions of PPP hold in the real life. Absolute purchasing power parity (PPP) holds when the nominal exchange rate o...
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Strong or Weak Dollar is Better? Strong is good. Weak is a bad thing. These generalizations sound simple enough, but they can be very confusing when it comes to money.
Economic indicators often affect and influence the value of a country's currency. The Trade Deficit, the Gross National Product (GNP), Industrial Production, the Unemployment Rate, and Business Inventories are examples of economic indicators. We will be dealing with four specific indicators: interest rate, inflation, unemployment, and employment growth, as well as Real Gross Domestic Product (GDP). Real GDP is so called because the effects of inflation and depreciation are accounted for in the figures. The state of the economy is important both on a micro and macroeconomic level.
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The purchasing power parity implies the following relationship between the home (GB £) and local (US $) costs of debt:
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The theme of this essay outlines two things. One, the key elements of Bretton woods system and second, the characterisation of Bretton woods system by Ruggie as ‘embedded liberalism’, and how far he succeeds in it. The Bretton woods system is widely referred to the international monetary regime, which prevailed from the end of the World War 2 until the early 1970s. After the end of the World War 2, the need of international monetary framework to boost trade and economic; growth and stability, was important. Taking its name from the site of the 1944 conference, attended by all forty-four allied nations; the Bretton Woods system consisted of four key elements. First, to make a system in which each member nation has to fix or peg his currency exchange rate against the gold or U.S. dollar, as the key currency. Secondly, the free exchange of currencies between countries at the established and fixed exchange rate; plus or minus a one-percent margin. Thirdly, to create an institutional forum, so-called International Monetary Fund (IMF), for the international co-operation on money matters: to set up, stabilize, and watch over exchange rates. Fourth, to remove all the existing exchange controls limiting (protectionism) policies by the members, on the use of its currency for international trade. In practice the first scheme, as well as its later development and final demise, were directly dependent on the preferences and policies of its most powerful member, the United States. According to John Gerard Ruggie, 1982, this Bretton woods system of monetary co-operation represented the type of liberalism which characterise “domestic social economic stability along with a liberal trading order.” He referred this system as ‘embed...
There have been deliberations about the ideal exchange rate system for a period of time, dazzling the advancement of the world economy and the manner of monetary policy.
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The first of these exchange rates, nominal, is the number of units of a given currency that can purchase a unit of a given foreign currency (INSERT CITATION). When using this rate, countries are able to value of their own currency relative to one-another when trading in the foreign exchange market. This principle, however, is not exclusive to trading currencies. Similar to the nominal exchange rate, the real exchange rate uses goods and services in place of currency. As a result, it is defined as the amount of goods or services that can be traded in one country for a good or service in another country. Using this rate, countries are able to gauge the competitiveness of their goods and services in trading with any given country, making it a key factor for countries trading in the global economy.
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