Purchasing Power Parity (PPP)
An implied exchange rate based on the ratio of price levels between two countries.
What is PPP?
Purchasing power parity (PPP) is an economic theory that exchange rates should adjust until identical goods cost the same in every country when priced in a common currency. The implied PPP exchange rate is simply the ratio of the local price to the US price for an identical basket of goods. If the actual spot rate differs, the currency is either over- or undervalued relative to PPP. The IMF and World Bank use PPP-adjusted GDP to compare economic output across countries in a way that accounts for differences in price levels rather than just market exchange rates.
Formula
Worked Example
2024 — Japan vs United States
Source: IMF — World Economic Outlook Database 2024 (2024-04-01)
Calculate PPP
Price of the basket/good in the local currency
Price of the same basket/good in US dollars
PPP-Implied Rate (local per USD)
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