Purchasing power parities v. exchange rates in international comparisons

Abstract

The scope and use of purchasing power parities (PPPs) to analyse real economic conditions in an international perspective is examined. The respective applicability of PPPs and exchange rates to different questions of comparative economic progress is described. The paper identifies where PPP adjusted nominal values are to be preferred over exchange rates as indicators for determining differences in levels of development and general human welfare. The choices are reviewed in a number of different policy situations. The arguments suggest that PPPs provide a reliable basis for strengthening economic policies to promote wide-scale international development and human progress. For international portfolio and financial transactions, asset and liability transfers (including debt settlements), however, exchange rates remain the appropriate conversion factors. Thus, there are comparisons where PPPs should be applied but elsewhere, as in most financial transactions, only exchange rates matter. But, in a wide range of policy contexts, such as marginalization and polarization, the nature of the analytical relationships cannot be properly understood without looking at PPPs and exchange rates together. This enables users to gain a fuller appreciation of the economic issues and to mine the potential richness of the data available.