Relative Purchasing Power Parity (PPP) Calculator

Local Country Inflation Rate (%)

Foreign Country Inflation Rate (%)

Old Exchange Rate ( \$ per foreign currency)

New Exchange Rate based on Relative PPP

\$ per foreign Currency

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New Exchange Rate based on Relative PPP

Foreign Currency per \$

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Notes:

#### Relative purchasing power parity: Calculate changes in exchange rate based on inflation in two countries

◦     the relative change in prices between countries over a period of time determines the change in exchange rates

◦     if the spot rate between 2 countries starts in equilibrium, any change in the differential rate of inflation between them tends to be offset

over the long run by an equal but opposite change in the spot rate

Example: 1£=1.6\$. US inflation rate is 9%. UK inflation is 5%. What will happen? Calculate the new exchange rate using the following equation.

(US inflation is 4% higher than UK  US products are 4% higher than UK  US customers convert \$ to £ to purchase cheap UK products This buying pressuring

of £ and selling pressure of \$  will force £ to appreciate  until the prices in UK are the same as in US   No benefits for US customers to buy from UK market.)

Math equation: ef= Ih- If  or ((1+ Ih)/(1+If) -1= ef;      ef: change in exchange rate;

h: home country; f: foreign country

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