Why do PPP exchange rates differ so much from market rates?

Market exchange rates reflect capital flows, speculation, and trade finance as well as goods prices. PPP captures only tradable goods price differences. Non-tradable services (haircuts, housing) are systematically cheaper in developing countries, creating the Balassa-Samuelson effect where market rates exceed PPP for poorer nations.

How is relative PPP different from absolute PPP?

Absolute PPP states the exchange rate should equal the CPI ratio between countries. Relative PPP states the percentage change in the exchange rate should equal the inflation differential. Relative PPP holds better empirically over long horizons but deviations persist for years in practice.

PPP Exchange Rate from CPI Ratio

Calculate purchasing power parity (PPP) exchange rate as the ratio of domestic to foreign price levels, and compare with the current market rate to identify over- or undervaluation of a currency.

Principal ($)

Annual Rate (%)

Years

Compounding / Year

$ Finance Disclaimer: These calculators are for educational and illustrative purposes only. Results do not constitute financial advice. Consult a licensed financial advisor before making investment or borrowing decisions.

How to Use

Enter the values for the scenario you are assessing. Calculate purchasing power parity (PPP) exchange rate as the ratio of domestic to foreign price levels, and compare with the current market rate to identify over- or undervaluation of a currency. Use the ppp exchange rate result to inform your calculation.

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