Is there a rule of thumb for absolute purchasing power parity to hold?

ABSTRACT

The validity of absolute purchasing power parity (APPP) between the pairs of 55 representative countries, along with their pooled data, is examined empirically. A rule of thumb for the validity of APPP is tentatively proposed. That is, for a pair of countries exhibiting the Penn effect, when the GDP per capita of one country is less than half of the other’s, it is very likely that APPP does not hold. However, when the GDP per capita of one country is greater than half of the other’s, there is a certain possibility that APPP holds.

KEYWORDS:

• Absolute purchasing power parity
• Penn effect
• real exchange rate
• rule of thumb
• validity

JEL CLASSIFICATION:

• F30
• F31

Acknowledgements

I am very grateful to Editor (Professor Mark P. Taylor) and three reviewers whose comments greatly improved the quality and readability of the paper. However, any existing errors or oversights are my responsibility.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ The term ‘the ratio of purchasing-power parity to the exchange rate’ in his paper is defined as the real exchange rate (RER) in Eq. (1) in this paper. A value of 1 for the RER indicates that APPP holds, while a value significantly different from 1 suggests that APPP does not hold. This argument of his has had such an important and far-reaching influence on later economists that many of us peers now take it for granted that APPP does not hold (between any pair of countries).