Empirical testing of PPP PPP not proved to be accurate in predicting future exchange rates. Two general conclusions can be made from these tests: PPP holds up well over the very long run but poorly for shorter time periods;and, 留 the theory holds better for countries with relatively high rates of inflation and underdeveloped capital markets
Empirical testing of PPP PPP not proved to be accurate in predicting future exchange rates. Two general conclusions can be made from these tests: PPP holds up well over the very long run but poorly for shorter time periods; and, the theory holds better for countries with relatively high rates of inflation and underdeveloped capital markets
Exchange Rate Pass-Through The degree to which the prices of imported and exported goods change as a result of exchange rate changes is termed pass- through. Although PPP implies that all exchange rate changes are passed through by equivalent changes in prices to trading partners,empirical research in the 1980s questioned this long- held assumption. For example,a car manufacturer,e.g.BMW,may or may not adjust pricing of its cars sold in a foreign country if exchange rates alter the manufacturer's cost structure in comparison to the foreign market. Pass-through can also be partial as there are many mechanisms by which companies can compartmentalize or absorb the impact of exchange rate changes. Price elasticity of demand is an important factor when determining pass-through levels
Exchange Rate Pass-Through The degree to which the prices of imported and exported goods change as a result of exchange rate changes is termed passthrough. Although PPP implies that all exchange rate changes are passed through by equivalent changes in prices to trading partners, empirical research in the 1980s questioned this long- held assumption. For example, a car manufacturer, e.g. BMW, may or may not adjust pricing of its cars sold in a foreign country if exchange rates alter the manufacturer’s cost structure in comparison to the foreign market. Pass-through can also be partial as there are many mechanisms by which companies can compartmentalize or absorb the impact of exchange rate changes. Price elasticity of demand is an important factor when determining pass-through levels
The Fisher Effect The Fisher Effect states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation. i=r+T+rTT This equation reduces to (in approximate form): i=r+ Where i nominal interest rate,r real interest rate and TT expected inflation. Empirical tests (using ex-post)national inflation rates have shown the Fisher effect usually exists for short- maturity government securities (treasury bills and notes)
The Fisher Effect The Fisher Effect states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation. i = r + π + r π This equation reduces to (in approximate form): i = r + π Where i = nominal interest rate, r = real interest rate and π = expected inflation. Empirical tests (using ex-post) national inflation rates have shown the Fisher effect usually exists for short- maturity government securities (treasury bills and notes)