Answer to Question #248978 in Macroeconomics for Charlie

Question

Why might an economy take long to achieve Purchasing Power Parity?

Answer 1

In the short term, exchange rate changes are influenced by news. Exchange rates are driven in the short run by announcements regarding interest rate adjustments, shifts in perceptions of economies' economic paths, and other factors. In contrast, PPP describes the long-term behavior of exchange rates. The economic dynamics that drive PPP will finally equalize currency purchasing power. However, this can take a long time. A four- to ten-year time horizon is normal. One of the major issues is that people in different nations consume extremely diverse sets of products and services, making comparisons of purchasing power problematic.