The Purchasing Power Parity Debate

Evaluating the regression analysis carried out, first of all taking all P values into account: We can see from all the tests carried out that P value remains constantly zero which indicates that the variables have been correlated very positively over the period. The interdependence of the variables are in perfect correlation such that the movement of the variables can be easily predicted. While analyzing the results from the T value we can see that except in the case of Uk currency against Japanese Yen, in all the other three cases the figure lies below 1.

06 thresh hold to be what is classified as significant. Hence the fluctuations in both the currencies will be felt equally on each other. Whereas in the case of the UK pound against Japanese Yen it is high at 6. 27. This implies that the effect of changes in the currency of Japanese Yen will have very insignificant effect on the UK pound. The final values are R-Sq values which are quite low in its percentage value for the exchange fluctuations. This shows no significance for the currency conversions. With the four figures being quite low there is again no clear relationship between the two variables.

There are factors affecting the dependant variable that are external to the independent one. This tie in with the low percentage figures of the coefficient. Both the percentages are low and hence the goodness of the fit of this model is relatively low and therefore the argument that the PPP theory can hold cannot be proved. However in the case of interest rate differences it is very high at 46. 9% and 43. 4% which signifies a high degree of correlation between the variables. PPP theory offers an idealistic view into the relationship between exchange rates and fluctuations and inflation.

However in a real world sense this cannot be the case. There are drawbacks that are apparent when considering the international trade. Trade relations between countries could be less developed. If tariffs and quotas are put in place, this will have some direct relevance into how much goods or services costs in a foreign market. From our analysis what we would expect to see is that PPP theory could be held based on the correlation between the exchange rate fluctuations in the two currencies we have considered.

When the PPP is held there should have been a perfect correlation between the currencies over the period. However the difference in the interest rate calculations does not show any correlation. This means that the varying interest rates affect the economic progress of the countries in different ways and the increase in the interest cost would lead to inflation. However all this does not mean that PPP theory is somewhat invalid. It may just mean that it is more suitable as a long term perspective. To see what results the currency exchange rates have on the inflation of a country, a long term view must be held.

Years may not be the enough time to see the effects of the exchange rate fluctuations as well as the interest rate differences. It would be ideal to do the regression comparing the exchange rate differences and the consumer price indices of two different countries; for example US and the UK as well as UK and Japan. This analysis may give more authentic results about the progress of both the economies in relation with each other.


1. Alan M. Taylor and Mark P. Taylor (2004) The Purchasing Power Parity Debate NBER Working Papers [online] Available