Purchase Power Parity Response
Requesting 200 words response to the following post using at least three substantive peer-reviewed scholarly journal articles (different than in the below post) to provide those substantive replies. You may utilize the main article as a reference.
Purchasing Power Parity and Why I Am Interested
Purchasing Power Parity (PPP) is a compelling research topic for two reasons. First, it is an interesting theoretical tool used for measuring and forecasting national and international economic cost approximations within the global economic system. It accomplishes this objective by looking at the foreign exchange rate between two currencies and determining the variance in price for a similar product. Finally, PPP is also used as a tool to simplify how we look at the complex array of global exchanges behind the creation and distribution of a product globally.
I am interested in conducting further research on PPP due to academic curiosity. Our assigned readings highlighted the perils of relying on it as an accurate theoretical measurement tool and an indicator of cross approximation across markets. PPP does not consider regional disparities in materials, quality, and production that are present when the same product is produced in myriad markets across the globe. Overall, having a better understanding of PPP and its strengths and weaknesses as theoretical measurement tool will enhance my comprehension of systemic economic data interactions in the future.
Explanation of Purchasing Power Parity
PPP is a theoretical metric that attempts to measure national or regional economic status or forecast economic trends. Specifically, it is an exchange rate theory that proposes that equivalent or similar products in different nations should have a comparable price when looking at the foreign currency exchange rate between the two nations’ domestic currencies (Satterlee, 2018). PPP offers a straightforward way of looking at price similarities and differences between the same or comparable products across the globe. Overall, it allows for an easier way of seeing how changes in exchange rates correspond to the changes in the price of a similar product between nations.
As I briefly touched on earlier, PPP does not consider differences in quality, materials, and production processes that are inherent in the global marketplace (Satterlee, 2018). With that in mind, it is important to remember two things. First, PPP is one of many economic indicators that should be taken into consideration when measuring an economic status or attempting to accurately forecast economic trends. Finally, PPP is not always useful in trying to understand imbalances in exchange rates.
Major Article Summary
Gyamfi (2017) conducted a study of Brazil, Russia, India, China (PR), and South Africa. Collectively, these nations are known as the BRICS nations and conduct a significant amount of trade between each other. In the study, the author looked at cointegration of exchange rates and relative prices. His study was focused on two outcomes. First, Gyamfi wanted to determine if the cointegration was linear or nonlinear amongst the BRICS. Linear cointegration would validate PPP and nonlinear cointegration would disprove PPP as an outgrowth of significant trade between the BRICS nations. Finally, he used the same data to determine the validity of the main supposition of PPP when measured between the BRICS and the United States. The main theoretical supposition is based on the law of one price. This theory was discussed in our assigned readings and simply means that the same product should have an approximate value across the globe (Gyamfi, 2017; Satterlee, 2018).
Gyamfi (2017) used monthly data on nominal exchange rates for the BRICS nations’ currencies against the U.S. dollar and consumer price index (CPI). The data used was from January 1993 to December 2015. The author used a two-part methodology to test these numbers and determine cointegration and the validity of PPP theory amongst the BRICS nations and the United States. He used the Rank and Score Testing of Breitung in his work. This is a test procedure based on rank that attempts to measure the concept of cointegration in a linear and nonlinear fashion (Breitung, 2001). Gyamfi’s work elicited two results. First, it determined that cointegration was only found between the United States and China (PR) during the period tested. Finally, the data provided numerical evidence that the main theoretical supposition behind PPP did not apply when looking for cointegration between the nominal exchange rates and relative prices of Brazil, Russia, India, and South Africa (Gyamfi, 2017).
Discussion
The work by Gyamfi demonstrates two factors when endeavoring to understand PPP’s strengths and weaknesses as a trend analysis and forecasting tool. First, while it is sometimes a viable explanatory mechanism, PPP is not always useful for providing correlative data between nominal exchange rates and relative price similarities and differences. It can be a valuable theoretical tool but must be viewed in concert with other factors. Additionally, it shows the caution that must be taken when looking at any economic indicator without additional context. While PPP can sometimes offer a straightforward metric to explain price similarities or differences between similar global products, it does not consider a host of other factors that influence foreign exchange rates and similar product price approximations across international markets (Satterlee, 2018). As with seafaring, economics is an art and a science that requires equal parts nuance, logic, knowledge, and a bit of luck. Overall, a holistic knowledge of market theory, metrics, and processes combined with an intimate understanding of cultural dimensions and their effects on a specific market will better equip a global manger to be successful.
As I discussed previously, Gyamfi (2017) used Rank and Score testing to determine if there was cointegration between the exchange rates and relative prices between the BRICS nations or between the BRICS nations and the United States. Cointegration would prove the validity of PPP. His findings determined that cointegration only existed between China (PR) and the United States and, thus, PPP validity only existed between these two nations during the period tested and not among the BRICS nations.
Rawlins (2016) conducted an empirical analysis of 19 developing Sub-Saharan African nations and five industrialized nations to test the main theoretical tenet of PPP. His findings raised significant doubts about the main theoretical supposition of PPP when looking at the African nations, but not when analyzing the industrial economies of the US, Japan, the UK, France, and Germany. Overall, it points to an inversely proportional relationship between PPP validity and a nation’s economic stability and stage of development.
Bahmani-Oskooee et al. (2015) conducted an empirical examination of the transitioning economies of Bulgaria, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, and Russia to determine if long-run PPP validity exists. The authors take a different approach by examining the real exchange rate instead of the relationship between the nominal exchange rate and relative prices. Overall, the findings demonstrated that there is weak evidence to support long-run PPP validity in the nations that were studied.
Chang and Tzeng (2013) studied the long-run PPP validity in Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Russia from 1995 to 2008. The authors utilized a complex combination of non-linear root testing to determine that long-run PPP validity does not exist between these nine transitioning nations. They do postulate that as these transitioning economies continue to open to trade, there will be stronger PPP correlation between the countries in the future.
Jiang et al. (2015) conducted an empirical analysis of 34 Organization for Economic Cooperation and Development (OECD) nations from 1994 to 2013. The analysis attempted to determine if PPP theory was valid in any capacity amongst the 34 nations. The authors utilized another form of root testing as part of their analysis. Overall, the results showed that PPP was valid for half of the 34 OECD nations analyzed. This fact is because OECD member nations range from industrialized to transitioning economies.
The scholarly literature I chose to focus on demonstrates two factors among the nations studied and analyzed. First, there is an inversely proportional relationship between PPP validity and a nation’s economic stability and stage of development. Finally, PPP remains a strong economic indicator for industrialized nations who participate in the global economy. Overall, PPP is a valuable economic metric if it is taken in context and used with other information.
References
Chang, T., & Tzeng, H. (2013). Purchasing power parity in nine transition countries: Panel SURKSS test. International Journal of Finance and Economics, 18(1), 74-81. https://doi-org.ezproxy.liberty.edu/10.1002/ijfe.457
Chun, J., Bahmani-Oskooee, M., & Chang, T. (2015). Revisiting purchasing power parity in OECD. Applied Economics, 47(40), 4323-4334. https://doi.org/10.1080/00036846.2015. 1026592/
Gyamphi, E. (2017). Testing the validity of the purchasing power parity in the BRICS: Further evidence. EuroEconomica, 2(36), 117-122.
Oskooee, M., Chang, T., & Wu, T. (2015). Purchasing power parity in transition countries: Panel stationary test with smooth and sharp breaks. International Journal of Financial Studies, 3(2), 153-161. https://doi.org/10.3390/ijfs3020153
Rawlins, G. (2016). Sub-Sahara’s experience with the purchasing power parity hypothesis. The Journal of Applied Business and Economics, 18(2), 22-27.
Satterlee, B. (2018). Cross Border Commerce (3rd ed.). Synergistics International Inc.
