Purchasing power parities (PPPs)

The concept of purchasing power parities (PPPs) lies in the area of tension between pure price statistics and the National Accounts, the establishment of which necessitates a not inconsiderable amount of time and money. In international comparisons of monetary values, however, PPPs allow analyses at equal price level and exhibit a more stable behaviour over time than exchange rates (XRs), as the latter are determined by supply and demand on the currency markets in the first instance, and also by direct monetary policy measures (e.g. interest rate fixing, currency decision-making). But other factors also play a role in determining exchange rates (catastrophes, psychological phenomena, speculation and political events) – they thus reflect other components besides pure price differences.

Definition

In their most elementary form, purchasing power parities are price ratios for a comparable product (a good or a service) in different countries. Prices in the national currency serve as a starting point. Comparisons on the basis of PPPs are thus founded on ratios of purchaser prices in different currencies for identical or comparable products (e.g. 1 kg rice, 1 bottle of whisky, 1 car, 1 PC, 1 night in a hotel, 1 meal in a restaurant). These goods and services are carefully defined in detailed product descriptions prior to the price survey and are selected taking into account their representativity. An overview on the basket of comparable goods and services used for the ECP Survey cycle 2016-2018 and including approximately 2 100 items is given in the table below.

Example: If one litre of Coca-Cola costs €2.00 in Austria and $1.60 in the USA, the PPP between Austria and the USA for this product would be 2.00/1.60. The quotient would thus be 1.25. In other words: For every US dollar that is paid for one litre of Coca-Cola in the USA, €1.25 would have to be paid in Austria to obtain the same quantity and quality (= the same “volume”) of this beverage.

In other words: PPPs indicate how many foreign currency units must be spent in order to purchase a comparable (part of a) basket of goods that can be purchased for one domestic currency unit in the given country.

PPPs are calculated as described above for an individual product (item) in the first instance, are subsequently aggregated into the smallest possible groups of goods and are finally aggregated to determine macroeconomic consumer demand.

Purchasing power standard (PPS)

As a set of currency conversion rates, purchasing power parities are inter-country price ratios that can be used to enable comparisons of monetary indicators of different countries, e.g. GDP per capita. In order to make such comparisons, the macroeconomic data must be converted into a common currency for all participating countries. Within the Eurostat-OECD Programme this artificial “EU average” currency is known as the “purchasing power standard” (PPS). The PPS can be interpreted as the equivalent of the euro with respect to purchasing power – as the euro in real terms. Mathematically, the original PPP of the given national currency is transformed to the PPP “National currency / PPS” by establishing the mean of the ratios of the national PPPs to all 27 EU countries.

Example: For Austria this would mean that the “AT-EUR/PPS” purchasing power parity can be calculated as a geometric mean from the following set of ratios: “AT-EUR/AT-EUR(= 1)”, “AT-EUR/BE-EUR”, “AT-EUR/DE-EUR”, “AT-EUR/DK-DKK”, “AT-EUR/UK-GBP”, etc.

Within the euro zone the common currency has simplified comparisons of prices in absolute terms, but a common currency does not mean that goods and services are offered at identical prices (despite certain convergence tendencies). Therefore the PPPs to PPS are different for different countries of the euro zone. Not all items in Austria, for example are as equally expensive or cheap as in Belgium or Germany, the purchasing power of one euro in Austria is different to that in these two countries. One “Austrian euro” may therefore differ from one “German euro” in its relation to the “average” currency PPS. The PPS is thus a reference value and can be seen as a specific combination of all EU currencies.

Uses

  • Conversion of national accounts aggregates into comparable volume aggregates. In particular, PPPs can be used to compare the Gross Domestic Product (GDP) of different countries without the figures being distorted by differing price levels in those countries.
  • Analysis of relative price levels across countries. For this purpose, the PPPs are divided by the current nominal exchange rate to obtain a price level index (PLI), which expresses the price level of a given country relative to others.

Application examples:

  1. GDP per capita in PPS (in absolute figures or as a volume index)
  2. Labour productivity per employed person [in PPS; compared with the EU27 (EU27_2020 = 100)]
  3. Comparative price levels of final consumption by private households including indirect taxes (EU27_2020 = 100)

See also European indicators

ECP-Product list 2016-2018


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