Thursday, January 17, 2013

Reading on PPP exchange rates

Here is some reading on purchasing power parity exchange rates:

The Sauder School of Business at UBC has a nice introduction

IMF has a good synthesis of the pros and cons of PPP exchange rates and official exchange rates, and more here.

Here is an interesting look at PPP from The Economist.

Here is a detailed article from Bank of Canada Review

One thing to note about PPP exchange rates is that they are typically not reported in an easy to use fashion like official exchange rates. Most often, what is reported is a PPP "conversion factor", which is the ratio of the PPP exchange rate to the official exchange rate.

Here is a list of PPP conversion factors from the World Bank.

Let's do an example... Consider the nation of Barbados....
2009 per capita GDP was approximately $27,720 Barbados dollars
The official (fixed) exchange rate is 1USD =  1.98 BD
This implies that per capita GDP is $14,000 USD

But, prices of non-traded goods are different in Barbados than there are here at home, so this may be an inappropriate estimate of average earnings. According to the World Bank, the PPP conversion factor for Barbados is 0.70.

This means PPP xrate/official xrate  = 0.70
PPPxrate/1.98 = 0.70
which implies that the PPPxrate = 1.386 BD to 1 USD (or 1 BD = 0.721 USD)

Hence, the per capita GDP of Barbados in purchasing power terms is really 20,000 USD.

For fun, go to gapminder world and plot GDP per capita against GDP per capita in PPP terms.
Notice that for most countries, PPP GDP > GDP.  Identify a country for which the PPP GDP < GDP.
What does this mean?


  1. Switzerland has a higher GDP than PPP GDP.
    A GDP > PPP GDP implies an overvalued currency for the nation under scrutiny. The Swiss Franc has had a long history of being overvalued--at some points the Swiss Franc has been called the most overvalued currency in the world. Keep in mind, "The Economist's" Big Mac Index has been quoted frequently when considering the Swiss Franc. Given the fact that the Swiss government imposes certain taxes on Big Mac "inputs" in order to protect Swiss farmers, the Big Mac index on Switzerland is likely skewed. In spite of this, other, more complex measures of calculating PPP still find the SF overvalued.
    More on the SF from a semi-recent article: