Purchasing Power Parity: Implication with respect to Pakistan and USA

Abstract

The basic aim of this paper is theoretical explanation of Purchasing Power Parity and its practical implication in the real world. The researchers tried to explain whether it holds in the real world or not, if not then what are major factors deviating its practical implication from that what the theory says about it. This paper specifically draws the findings how actually exchange rate moves with the domestic and foreign price index. This study is based on the historical prices indexes of two countries Pakistan and USA pertaining the period from 1980 to 2011. So our sample size is two with the number of observations equal to 31. The results of this research expressed the findings that the Exchange rate (Pakistani rupees per dollar ) increases with the increase in the domestic price index, means home currency will depreciate against the foreign currency. These findings are drawn on the basis of beta coefficients obtained from the regression analysis. The research results expressed that PPP holds to some extent which shows that inflation differential has a considerable impact on exchange rate movement but it is not the only factor.

Keywords: Relative PPP, Absolute PPP, IRP, Exchange rates, Inflation rate differential.