Thanks to modern treatment of this theory to Gustav Cassel in the early twenties of the 20th century AD and off the basic idea of this theory is the fact that the value of the equilibrium of the currency in the long run is determined by the ratio between domestic prices and external prices, in the sense that the exchange rate of a currency is determined on the basis of what could be buy the currency at home and abroad, hence the cost of buying the items are, for example, in the United States must be equal to the cost of buying it in the UK, this means that if the state D know the inflation rate is higher than that prevailing in the state E, the state D seeks to raise its imports of products the state E, because prices there are less increased, and at the same time decrease the country's exports D because the prices of their products to be more increased, and as a result of the emergence of a trade deficit for the state D and this is what leads to the direction of the state D towards reducing its currency compared to the currency State E and realize the value of a new tie.
Thus:
The exchange rate of the currency in real time g 0 Price Index abroad
ــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــ =
Real-time exchange rate expected for the currency in 1 g Price Index at home
I have been selected this theory turned out to be of significance in the long run than in the short term as the few currencies that important in the movement of international capital less responsive to the theory of purchasing power parity.
However, this theory raises some outstanding issues, including:
- The different methods of measuring inflation by type of consumption prices prestigious prices, producer prices, the prices of exports and imports .. etc..
- The length of correct exchange rates to prices is specified accuracy, and the same applies to the base year.
- There are other elements of the non-price affect the balance of trade and balance of payments, especially the elasticity of demand for income and for the price, as well as the flexibility of exports and imports for the same variables.
- The theory of purchasing power parity is not only related to the balance of current operations rather than the full balance of payments.
- Think of this theory that we can estimate the rate of inflation in all countries, regardless of the evolution of statistical systems and media.
- Authorities are available on the economic and other means by which to influence the balance of payments deficit.
- The presence of some goods and services that do not fall within the scope of international trade for several reasons.
- There are several other factors to determine the exchange rate, such as changing consumer tastes and the emergence of alternative products ... etc..
- There is the problem of discrimination in the dependent variable and independent so that the theory imposes price level independent variable and the exchange rate is the dependent variable.
- A country can assess whether its currency denominated in a higher or lower given the purchasing power parity.
And the success of the theory of purchasing power equivalent to:
* The rule of freedom of international trade, so that the existence of restrictions would settle prices.
* The rule of free transfer of money from one country to another and not be subjected to surveillance systems.
التسميات
Financial concepts