Comparing Apples with Apples
in Different Currencies

It isn't the same to buy a Big Mac in Peru than in the United States, and it's not about the size of the hamburger. The difference lies in this: how many Big Macs can you buy in each country with the same amount of money?

To compare the relative purchasing power of two currencies, applying the exchange rate is not enough. The mere transformation, in this case, from Peruvian nuevos soles to U.S. dollars, will not necessarily buy the same amount of goods in the two countries.

This difficulty is due to several factors, such as short-term fluctuations in international capital movements, policy interventions on exchange rates or the fact that some goods and services are not traded internationally.

Making this comparison requires exchange rate parity, or Purchasing Power Parity (PPP). This is the rate at which the currency of one country would have to be converted to the currency of another country in order have the same purchasing power in both countries.

The Big Mac index, designed and published by The Economist, is a well-known example of PPP based on one consumer good. If, for example, the hamburger costs $8 nuevos soles in Peru and in the United States it costs $3.50 dollars, the PPP rate based on the comparison of this product is 2.29 ( = 8.0/3.5). This means that 22.9 nuevos soles can buy the same amount of Big Macs in Peru as 10 dollars in the United States.

In general, however, using PPPs based on the comparison of only one product is not appropriate. PPPs should be calculated considering comparability as well as the representativeness of a basket of goods and services that reflect real consumer and spending patterns.

Knowing the amount of goods and services that may be purchased in one country with the equivalent of a certain amount of currency from another country is necessary for several reasons. One is that applying the PPP allows international comparisons of economic aggregates like the Gross Domestic Product (GDP), the most frequently used measure to represent the size of a country’s economy.

A country’s GDP is expressed in its national currency, and this requires that national GDPs be converted to a common currency. However, as mentioned above, the use of exchange rates as a means for comparison is insufficient.

The 2011 Round of the International Comparison Programme (ICP), which seeks to estimate PPPs for that year of reference, began a few months ago. This is the most ambitious statistical project at a global scale, involving over 170 countries. As in the previous 2005 Round, ECLAC will coordinate the project in Latin America and the Caribbean.

To calculate PPPs, participating countries will provide the average national prices of hundreds of goods, whose specifications have been defined with a great amount of detail in order to ensure that countries are measuring items and goods that are both comparable and representative.

The price of these items will be collected an average of four times during reference year 2011 in many markets and sales locations –rural and urban, formal and informal- to obtain the average national price. The PPPs will then be estimated based on the average relative prices of comparable goods among countries.

The enormous complexity of the PPP project lies in the need to harmonize methodologies, concepts and definitions for the collection and validation of data, as well as for calculating estimates.

Carrying it out implies a significant effort on the part of intervening countries, whose statistics agencies – National Statistics Bureaus and, in many cases, Central Banks as well - must gather prices and prepare national accounts data in order to obtain the PPPs of the different components of their GDP. This task is supported by a management and coordination structure at a global level that includes a number of international agencies.

The project is relevant in several aspects.  In the first place, the information that will be generated from the PPPs is highly important and includes indicators for the analysis of the region’s economic situation and the design and monitoring of public policies.

Secondly, the tasks related to the PPP project itself can facilitate the harmonization of statistics practices and the adoption of international standards and classifications for different countries in the region.

Third, the programme will allow countries to increase their technical capabilities in price statistics and national accounts.

*by Statistics and Economic Projections Division