• Research Paper on:
    Purchasing Power Parity and the Balance of Payments Approach

    Number of Pages: 3


    Summary of the research paper:

    This 3 page paper looks at how the monetary approach of balance of payments may be used to explain how purchasing power parity is observed and spot price differences vary. The bibliography cites 8 sources.

    Name of Research Paper File: TS14_TEBoPPPP.rtf

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    undermined the idea of purchasing power parity. It has been argued that the monetary approach with the balance of payments can be used as a way of complimenting the shortfalls  or extending the model. The purchasing power parity is based on the Law of One Price this is a no arbitrage  condition that tells us the price in two different nations should identical when the currency is converted into that of the comparative nation. The deviations from PPP can be  partly explained by the International Fisher Effect (IFE) (Nellis and Parker, 2000). This amendment to PPP states that when interest rates are different and change the spot exchange rate should  also change by a proportionate amount in the direction opposite to the interest rate change (Nellis and Parker, 2000). This relies on the real interest rate across the comparative nations  being equal, however as it is bases on PPP it is also found that in practice it doe not hold true (Cuddington and Laing, 2000).  Although purchasing payment parity it may hold true in the short term, long term studies have demonstrated many cases where it is found to be inaccurate when  examining spot prices. It has been argued that the monetary approach of the balance of payments can be seen as providing reasoning. It has been argued that the balance of  payments concept has a strong connection to the complete arbitrate assumptions within commodities and financial assets (Brakman and Jepma, 1981). While it has appeared that the balance of payment approach  can add value to the understanding of purchasing power parity and its apparent contradictions, De Roos (1981) has undertaken research which indicates that there is not the assumed correlation with 

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