Relative Purchasing Power Parity
Relative purchasing power parity (RPPP) is an expansion of the traditional purchasing power parity (PPP) theory to include changes in inflation over time. Purchasing power is the power of money expressed by the number of goods or services that one unit can buy, and which can be reduced by inflation. RPPP suggests that countries with higher rates of inflation will have a devalued currency.
Definition:
Relative Purchasing Power Parity (RPPP) is an extension of the traditional Purchasing Power Parity (PPP) theory. RPPP takes into account changes in inflation over time, positing that a country with a higher inflation rate will see its currency depreciate relative to others.
Origin:
The Purchasing Power Parity theory was first introduced by Swedish economist Gustav Cassel in the early 20th century. RPPP evolved from this theory to explain exchange rate changes due to differences in inflation rates between countries.
Categories and Characteristics:
1. Absolute Purchasing Power Parity (APPP): Assumes that in the absence of transportation costs and trade barriers, the price of the same goods should be equal across different countries.
2. Relative Purchasing Power Parity (RPPP): Considers changes in inflation rates, suggesting that exchange rate changes should equal the difference in inflation rates between two countries.
Characteristics: RPPP is more realistic as it accounts for the effects of time and inflation.
Specific Cases:
1. Case One: Suppose the inflation rate in the United States is 2%, while in Japan it is 1%. According to RPPP, the USD should depreciate by approximately 1% relative to the JPY.
2. Case Two: If the inflation rate in the UK is 3% and in the Eurozone it is 1%, the GBP should depreciate by approximately 2% relative to the EUR.
Common Questions:
1. Is RPPP always accurate?
Not necessarily. RPPP is a long-term theory, and short-term exchange rates can be influenced by other factors such as interest rates and political events.
2. How to apply RPPP in investment?
Investors can compare inflation rates between countries to predict long-term exchange rate trends, but should be aware of short-term volatility risks.
