Introduction to Foreign Exchange Rates

CHAPTER 4

Extensions of Purchasing Power Parity

In this chapter, we cover some extensions to the connection between goods prices and foreign exchange (FX) rates and the role of goods prices in determining intrinsic FX rates. First, we cover how inflation rates affect intrinsic FX rates. We'll apply this idea to understand how FX misvaluations occur in a setting where FX rates are fixed. Second, we cover an adjusted version of absolute purchasing power parity (APPP), where the adjustment is based on an economy's per-capita gross domestic product (GDP).

Relative Purchasing Power Parity

There is an extension of the international law of one price (ILOP) and APPP conditions that has to do with FX rate movements over time. This dynamic version of the ...