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Relative PPP Versus Price-Level PPP for Exchange Rates

Article Quant Q&A · Author: user15772
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Summary

The document distinguishes relative purchasing power parity (PPP) from price-level PPP, two approaches that can produce different estimates of an exchange rate. Relative PPP projects exchange-rate changes from inflation differences between two countries over time. The questioner reports that this calculation does not match a published euro–dollar PPP series, prompting clarification about the kind of measure being compared.

The answer suggests that the published series is likely a bottom-up aggregate based on comparing prices across countries, such as an index produced by the OECD. It says the two approaches can be equivalent under particular economic assumptions, but those assumptions do not hold empirically in general, and the calculation methods differ in practice. A second response points readers to Eurostat’s methodology manual. The document gives no worked price comparison, numerical example, or detailed formula for constructing an aggregate PPP rate, so it identifies the conceptual distinction without teaching the full calculation.

Key ideas

  • Relative PPP relates exchange-rate movements to inflation differences between countries.
  • Price-level PPP aggregates comparisons of prices across countries and is constructed differently from relative PPP.
  • The two measures may coincide under specific economic assumptions, but practical estimates can diverge.
  • The document points to OECD and Eurostat materials for further methodological detail.

Tags

ForexStatisticsMulti-asset
Full text
# How do I calculate the PPP adjusted exchange rate between two countries?


# How do I calculate the PPP adjusted exchange rate between two countries?












I have been trying to calculate the PPP-adjusted EURUSD exchange rate. I am not sure if it is the same as relative PPP, for which I have used this formula:

Spot rate at time t = Current spot rate * ((1+inflation of country A)/(1+inflation of country B))^t

With this formula though, my values for PPP don't at all look like Hussman's.

Euro PPP exchange rate

## Answer by mgilbert (score 1)

https://quant.stackexchange.com/a/18245

What you are looking at is relative PPP, which claims that exchange rate movements are explained by relative inflation movements, see wiki. However from the picture I would guess he is looking at a bottom up purchasing power parity aggregate, which as @user1483 eluded to, is a different calculation. There are several providers of this type of index, the OECD provides one. A brief description of their methodology is explained here and a more detailed description can be found here. Ultimately the two are related and under a set of set of economic assumptions on the world (which don't hold empirically) are equivalent however practically speaking the calculation methodologies are quite different and will yield different results.

## Answer by user1483 (score 0)

https://quant.stackexchange.com/a/17305

Eurostat has a manual on the calculation and use of PPP. This is available here.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.