Question

Respond with your thoughts 150 words

Personally, I do not agree with the statement that purchasing power parity (PPP) and interest rate parity (IRP) are without any problems. Purchasing power parity, though I do agree that it may be a useful method for comparing the market environments of different nations, has several imperfections. First and foremost, it is difficult to accurately assess the true value of goods across the globe. Granted, this may be the reasoning behind the so called “Big Mac Index,” due to the fact that measuring the costs of the widely-distributed sandwich across 119 countries is able to paint a somewhat simplified picture of comparative prices. In addition, purchasing power parity also fails to address other external factors, such as trade agreements, trade restrictions and government influence…particularly in the form of subsidies for certain goods. To that end, despite the numerous criticisms that seem to be facing purchasing power parity, it does seem to be a useful tool nonetheless. This is due to the fact that PPP tends to equal itself out (more or less) over a long enough period of time. As a result, it is able to assist in predicting variations in the exchange rate over long periods of time.

As for the interest rate parity, it is also not without its imperfections. The concept behind interest rate parity is that it uses interest rates, relative to one another, in order to analyze the future rates of currencies. The theory contests that interest rate differentials will automatically adjust in order to prevent arbitrage. While this concept may hold merit, the interest rate parity theory in and of itself still maintains some inaccuracies. The assumption that no arbitrage opportunities are available takes away from the overall accuracy of the theory. That being said, assumptions are generally accepted in many practices (I have to make tons of assumptions in engineering) and the end result will end up being “close enough” so that the goal at hand may be achieved. For interest rate parity, the goal is to determine the relationship between these interest rates and how they ultimately affect exchange rates. So, despite assumptions and inaccuracies, it seems to achieve this end goal.

Answer 1

answer-

It is true that any economic theory is not perfect because these theories are based on assumptions like purchasing power parity assumes that people living all around the world have equal purchasing power then how they can justify the factors like economic conditions of the countries which can affect the purchasing power of the people. for example- in US which is high developed country has people having high purchasing power but people in underdeveloped countries like Bangladesh,Bhutan having people with low purchasing power also employment rate can not be equal in all countries which also makes this theory not true.

as for Interest rate parity, i agree with your beacause Interest rate parity (IRP) is a theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate there are some assumptions and problems present in these economic theories.