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Economists wish to compare prices, real income, and output across countries and regions for many purposes. In the past, such comparisons were made in nominal terms, or by using exchange rates across countries, ignoring differences in price levels and thus distorting the results. Great progress has been made in interspatial comparisons in the past thirty years, but descriptions and discussions of the new measures have been scattered in unpublished or inaccessible papers. International and Interarea Comparisons of Income, Output, and Prices includes discussions of developments in the United Nations International Comparison Program, the largest effort in this field, and in the ICOP program on the production side, including efforts in both to extend the comparisons to the formerly planned economies. Other papers in this volume explore new programs on interspatial comparisons within the United States. There are also theoretical papers on how interspatial comparisons should be made and several examples of uses of such comparisons.
The International Comparison Program (ICP) is a worldwide statistical partnership to collect comparative price data and compile detailed expenditure values of countries' gross domestic products (GDP), and to estimate purchasing power parities (PPPs) of the world's economies. Using PPPs instead of market exchange rates to convert currencies makes it possible to compare the output of economies and the welfare of their inhabitants in real terms (that is, controlling for differences in price levels).
This chapter presents a review article on the purchasing power parity (PPP) theory of exchange rates. The PPP theory involves the ratio of two countries' price levels or price indices times a base period exchange rate as the most important variable determining the exchange rate, but it allows both for other explanatory variables and for random influences. Criticisms of PPP include the existence of tariffs and transport costs, the role of income in exchange rate determination, and the existence of noncurrent account items in the balance of payments. The direction of causality (prices to exchange rates) has also been called into question. Several kinds of tests of the PPP theory have appeared in the empirical literature. One test demonstrates that the ratio of PPP to the exchange rate is systematically related to differences in per capita income across countries. Other tests correlate time series of PPP and the exchange rate or perform a comparative-static comparison of the two variables over time.
This volume provides a comprehensive review of the statistical theory and methods underlying the estimation of purchasing power parities (PPPs) and real expenditures, the choices made for the 2005 International Comparison Program (ICP) round, and the lessons learned that led to improvements in the 2011 ICP.
In View of the continuation of substantial movements in exchange rate relationships among major currencies, the recent increase in protectionist pressures, and the disappointing performance of world trade, renewed concern has been expressed about the possible adverse effects of exchange rate variability on trade. Against the background of this concern, the following decision was reached at the ministerial meeting of the General Agreement of Tariffs and Trade (GATT) in November 1982.