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Purchasing power parity – the shopping basket, fast food and the euro-franc exchange rate News

Tuesday, August 22nd, 2017 | Economy

At the end of July, the euro has reached an exchange rate of up to 1.1538 as of the abolition of the share price limit in January 2015. In all discussions about further price rises, possible national bank interventions and secret upper and lower boundaries, the issue of purchasing power parity is once again the center of attention. Or how the term in English means: Purchasing Power Parity (PPP).
What exactly is this and how is this relative to the current monetary movements? Key facts at a glance.
What is the purchasing power parity?
In the longer term, the exchange rate of a country or a currency area should move around purchasing power parity. Economists compare commodity baskets and services in these rooms. Purchasing power parity helps them to assess whether a currency is overvalued or undervalued. Parity exists when the products can be purchased for the same price. Two currencies thus have the same purchasing power. Furthermore, purchasing power is also used to look at prosperity in a country in relation to other countries:
The 25 Richest Countries In The World Based On Purchasing Power Parity Of GDP Per Capitaequa
Rank Country GDP … https://t.co/3vt5fSHxSo
– MOORTHY (@moorthymee) August 19, 2017
Can this be explained by an example?
Suppose an iPhone costs in Germany converted 40 per cent less than in Switzerland. This would create incentives to sell iPhones from Germany on a grand scale in Switzerland. However, as a result of the increased demand, the price of iPhones in Germany would also rise. At the same time, the increased export demand for iPhones would also trigger more demand for euro – with the result that the euro would be stronger and the franc weaker.
Both the relative price development for iPhones and the euro-franc exchange rate would react in this thought experiment until iPhones inversely cost the same and thus no longer incentives to export iPhones to Switzerland.
Is this theory generally accepted?
"Relative price developments and the exchange rate are closely linked in the long term," says Felix Brill, economist and CEO of the consulting company Wellershoff & Partners. The relationship of purchasing power acts as a basic force. From his point of view, purchasing power is one of the most important factors influencing currency developments in the long term.
"Purchasing power is an important long-term factor for currencies, but it is not the only one for us," said Marktstratege Florian Weber from the bank J. Safra Sarasin. For the fair value of a currency pair, it is also important factors such as gross domestic product, interest rate differential or political risks.
On the other hand, the purchasing power of Thomas Steinemann, bank manager of Bank Bellerive and economist, is little noticed. "It still has a certain significance in the very long-term range, ten years – but does it benefit someone?" For the short and medium term, purchasing power parity is unsuitable as a guide.
Where is the purchasing power parity for Euro-Francs?
Economists indicate purchasing power with a bandwidth. As with analysts' forecasts on company numbers, economists operate with differently assessed parameters, such as the underlying inflation rate. Wellershoff & Partners has a purchasing power of between 1.16 and 1.30, while J. Safra Sarasin is between 1.10 and 1.35, with an average value of 1.23.

The development of the euro-franc exchange rate (blue) in relation to purchasing power parity (red). In January 2015, the currency exchange rate, in response to the abolition of the price cut-off, differs significantly from the range of purchasing power parity. (Graphic: Wellershoff & Partners).
In this view, however, today's Euro-Franc exchange rate is already in an area where a neutral valuation can be said. The purchasing power parity thus makes statements that the franc is clearly over-valued to the euro, as the national bank continues to lead the field. The view of the Swiss trade unions that the fair value of the euro-franc exchange rate is at least 1.30 can not be considered under this view.
Can the euro-franc rate be predicted?
No. The volume for the purchasing power of the economists of J. Safra Sarasin is between 1.10 and 1.35, but the price target for the euro-franc ratio by the end of the year is 1.10. Also advocates of purchasing power indicate that economic and political events are more important in the short term and thus "misjudging".
However, they feel again confirmed by the recent developments. Dollar and the Swiss franc were the strongest "mispriced" of the major currencies at the beginning of the year: the dollar, because of the high expectations of the trump presidency, the franc as a currency of curiosity due to great political uncertainties. However, the fact that the dollar against the euro unexpectedly declined by 13 percent since the beginning of the year and the euro has appreciated by 6 percent against the Swiss franc is interpreted as a sign that the underpowering forces are acting in terms of purchasing power parity.
Is the famous Big Mac index the same?
The exact same is not. The Big Mac index, published by the English weekly "Economist" since 1986, actually reflects the purchasing power of different countries, because the same product – a McDonald's Big Mac – exists almost everywhere in the world. However, only one product is compared to the theory of purchasing power, which works with goods baskets.
The Bic-Mac index is an easily understandable and impressive barometer, which reveals differences in purchasing power. As of July 2017, the price of a Big Mac is highest in Switzerland (6.74 dollars), followed by Norway (5.91 dollars) and Sweden (5.82 dollars). The cheapest is the calorie-rich fast-food favorite in Ukraine (1.70 dollars), Egypt (1.75 dollars) and Malaysia (2 dollars).


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