购买力平价理论的实用性

Analyze the Applicability of the Purchasing PowerParity TheoryThe purchasing power parity theory was put forward by the Swedish economist Cassel in 1922. "The general inflation which has taken place during the war has lowered this purchasing power in all countries, though in a different degree, and the rates of exchange should accordingly be expected to deviate from their old parities in proportion to the inflation of each country. At every moment the real parity is represented by this quotient between the purchasing power of the money in the one country and the other. I propose to call this parity "purchasing power parity"(Cassel, 1918).In Cassel’s view, the price of the currency depends on the purchasing power of the goods. The ratio of purchasing power is called as purchasing power parity. Movements in exchange rates ultimately depend on changes in the ratio of price levels between the two countries. But at the same time to present ideas Cassel theory also pointed out the establishment of this theory must meet the some conditions: 1. The purchasing power per unit of currency is determined by the amount of money supply. In the case of a certain supply of goods, as the money supply is more, the purchasing power per unit of currency is lower. 2. The theory must meet the law of one price. It means under free trade conditions, every piece of merchandise on the world market regardless of where it would be sold the sale prices are the same (net of transport costs). The theory assumed that there were no barriers and transaction costs betweenthe two countries’ trade.What’s more, market prices should change with changes in supply and demand. In summary, based on purchasing power parity theory, the exchange rate is the PPP’s unbiased estimator in a world economy fully open, fully trade and the market is fully effective.The main attraction of purchasing power parity theory lies in its inherent simplicity. Analyzing currency exchange issues from the perspective of the purchasing power is very logical. Therefore, PPP is widely used in analysis and policy research on the exchange rate level. But if it was established there has been considerable controversy. Keynes noted that the PPP had some guiding significance, but there is the possibility of departure from the PPP (Keynes, 1923). Keynes noted that Kassel ignored the impact of capital flows on exchange rates. And he came up with the interest rate parity theory pointed the forward exchange rate is determined by the spreads between different currencies.In addition to derive many new theories, the purchasing power parity theory itself is constantly revised. Balassa officially argued that the PPP systematic productivity deviation (Balassa, 1964). In his theory, a State may trade goods for the law of one price. The industrial wage increase may be promoted by the raising the productivity of tradable goods, thus promoting the national wage increases. On the other hand, the productivity of the non-tradable goods cannot be synchronized to enhance, thus costs and prices will inevitably rise. The country's relative price level rose at last. The actual economic factor changes will make the nominal exchange rate and PPP permanent deviation. Therefore, the formation of the Balassa - Samuelson modelcame from the amendment to the PPP. Kravis and Lipsey also reached the same conclusion. They emphasized the labor-rich poor countries compared with the capital adequacy rich countries, and found the poor countries had much cheaper non-tradable goods because of their lower cost of labor (Karvis and Lipsey, 1983).In 1978, Frenkel concluded that PPP theory cannot be used as exchange rates and prices contact mechanism, and it can only be regarded as a shortcut to prices and exchange rate determination (Frenkel, 1978). This conclusion was posted after verifying the relationship between exchange rate changes and the price ratio among the two countries use different price indices.In any case, economists admit there are some links between the exchange rate and price changes. But even so, the analysis from theory of PPP of the real economy still has many defects. First of all, the purchasing power parity theory is in a purely ideal state which there is no trade barriers, transportation costs, foreign exchange control. This ideal state is far away from the real-world economic and its operating conditions. Second, PPP theory analyzes exchange rate issue from the currency level factor. It assumes that only the price can impact exchange rate from the perspective of international trade. The PPP neglects other factors, such as interest rates, monetary supply, fiscal policy, foreign exchange market intervention, the hot money flow Move, macroeconomic shock and so on. "The experience during the 1970s illustrates the extent to which real shocks result in syst ematic deviations from PPP.”(Frenkel, 1981). In fact, in the short to medium term, the impact of international capital flows and exchange rates of countries have far greater effect than the purchasing power parity.Next part of this essay will analyze the 1994-2005 RMB exchange rate and RMB PPP in this period to actually demonstrate whether the purchasing power parity theory established in the real economy. Table 1 describes the 1994-2005 price level in China and the United States, as well as the ratio of the price level of the two countries (take 1994 as the base period). Table 2 describe the inferred exchange rates based on 1994 exchange rate according to the PPP theory and the real exchange rate for each year. Table. 1Year China's Price Level US Price Level Ratio of Price Level1994 100 100 1 1995 117.1 102.83 1.139 1996 126.82 105.87 1.198 1997 130.37 108.3 1.204 1998 129.33 109.99 1.176 1999 127.52 112.42 1.134 2000 128.03 116.19 1.102 2001 128.92 119.5 1.079 2002 127.89 121.39 1.054 2003 129.43 124.16 1.042 2004 134.47 127.46 1.055 2005 136.89 131.78 1.039Data come from: /Table. 2Data come from: /Reflected by the above two icons, we can draw: calculated data based on PPP theory of exchange rate doehs not match the actual market exchange rate in China, and in some years the data even showed the opposite trend. This shows that the theory of PPP does not have strong explanatory power of the exchange rate in China. The following analysis through these 13 years will point out the relationship between the PPP theory and the RMB exchange rate more specifically.The first phase (1994-1997): China experienced a high rate of inflation at this stage. RMB against the U.S. dollar has increased a bit. China's inflation rate in 1994 was over 20%, and in four years the average inflation rate was 11.3% higher than that of U.S. At the same time the increase in the value of the RMB was clearly not match the purchasing power parity, and the magnitude of change was also a serious departure from the theory of PPP.The second phase (1998-2002): RMB exchange rate retained stabile while a deflationperiod, which resulting in a severe devaluation expectation. Speculated data by PPP during this time had greater differences with the real exchange rate.The third phase (2002-2005): China's inflation emerged again, but the RMB exchange rate keep stable with a bit increase. The gap between real exchange rate and PPP estimates exchange rate reduced than before. In fact, this situation was a result of the Chinese government took national exchange rate regime as an effective means of regulating the economy.This case further illustrates the considerable defects of the theory of PPP in the real economy. Despite two points mentioned earlier in this article, there are other reasons: First, there are some defects and limitations of the PPP theory itself.1. The choice of price index is the core content of the PPP theory. Which index is most appropriate is difficult to decide in this issue. Using Consumer Price Index to represent the frequent inflation rate, to some extent, is contrary to the "law of one price which takes tradable goods to compare the contents as its theoretical premise.2. In the calculation of the relative purchasing power parity, the choice of the exchange rate of the base period is very important. It generally based on the year which international payments are relative balance as the base period exchange rate. This article selects 1994 as the base period, and this is relatively effective, but not very accurate.3. The PPP theory is in fact a theory as to determine the long-term exchange rate. In the short term, due to sticky prices and other reasons, the PPP cannot quickly adjust. Exchange rate will change frequently due to various reasons. Therefore, the exchangerate is often a temporary deviation from PPP.Second, it is difficult to guarantee the product selected in the theoretical model is fully representative. When using PPP to calculate the exchange rate, it requires two comparison countries to achieve consistency and comparability in the classification of goods. For example, China is the countries with abundant labor resources. The main current industrial structure is labor-intensive, and the relatively abundant labor resources make wage in a low level. Therefore, China's price level is low, especially in labor-intensive product. If use the PPP theory to calculate the purchasing power of RMB bluntly, it would lead to the conclusion of the RMB is significantly undervalued. In real life, due to the differences in national socio-economic development level, the level of consumption, consumption habits and other fields between different countries all over the world, the actual calculation of purchasing power is faced with many unresolved problems.Third, as the analysis object, the reality of the economic system in China has its uniqueness.1. China’s economic system and the price mechanism is imperfect currently, which leads to overestimation of the purchasing power of money in China. China's market economy development level is still relatively low. Government public-sector projects and services are still given subsidy, which would cause serious price distortions.2. As China's economic strength is still weak, compared to such economic power in the United States, the price index is bound by those developed countries. Developed countries have the vast majority of the total of all economic. As long as the value ofindicators in the comparison will be the basis of the calculation of weights, the impact of developed countries are inevitable.3. The prerequisite for PPP’s establishment is a full free trade condition. In China, there are still a variety of barriers to trade, monopoly and government control, etc. Other economic factors such as the implementation of monetary policy, exchange rate policy, and political factors will allow the nominal exchange rate movements not only related to changes in price levels. This is contrary to the premise of PPP theory.The PPP theory is one of the most influential theories on the decision of the long-run equilibrium exchange rate. Its form of expression is more intuitive than other exchange rate theory. The theory of purchasing power parity has drawn attention by the governments all over the world since it was proposed by Cassel. Through reality of data collection and comparative analysis of the actual number of table graphics, we recognize the authority theory PPP is not applicable at all times. Thus, the application of theory requires certain conditions of the times and the objective environment. As the time and objects of study change, the theory needs further rehabilitated and improved.BibliographyCassel, G. (1918) Abnormal Deviations in International Exchanges, Economic Journal, December.Cassel, G. (1916) The Present Situation of the Foreign Exchange, Economic Journal, March: 62-5.Keynes, J. M. (1923) A Tract on Monetary Reform, MacMillan and St. Martin's Press for the Royal Economic Society, 1971.Balassa, B. (1964) The Purchasing Power Parity Doctrine: a Reappraisal, Journal Of Political Economy,72,No.6, Dec.1964.Kravis, I. and Lipsey, H. (1983), Toward an Explanation of National Price Levels, Princeton Studies in International Finance, No.52, Princeton University Press. Frenkel J. A. (1978) Purchasing Power Parity: Doctrinal Perspective and Evidencefrom the 1920s, J. Int. Econ., May 1978, 8(2).Frenkel, J. A. (1981) Flexible Rates, Prices and the Role of `N ews’: Lessons From the 1970s. Journal of Political Economy, 89, 665-705.。