If so, what is the difference between purchasing power parity and relative purchasing power parity?
I just saw a relative purchasing power parity question in the practice assessment - tremblay, but I can’t find much on it in the book. I remember it was in last year’s exam, did they take it out?
'Absolute PPP" states that exchange rate is determined by the broad price index levels in the two countries. “Relative PPP” states that exchange rate is determined by ‘inflation rate’ difference, essentially stating that inflation is a good substitute for ‘price’ differential.
‘ex-ante PPP’ states that exchange rate is determined by ‘expected’ inflation rate difference, which is what Fisher’s equation is all about.
It’s in the curriculum.
PPP (law of one price): P foreign = P domestic * S foreign/domestic
Absolute PPP: S foreign/domestic = Foreign general price level / Domestic general price level
Relative PPP: E (St foreign/domestic) = S0 foreign/domestic * [(1 + foreign inflation) / (1 + domestic inflation)] ^t