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Fundamental analysis

Purchasing Power Parity

By Jarosław Wasiński • Published: • Updated:
Purchasing Power Parity (PPP) is a theory of currency valuation holding that, over the long run, an exchange rate should equalise purchasing power, so the same basket of goods should cost the same in both countries once converted. A popular illustration is the Big Mac Index published by The Economist. In practice PPP is a reference for long-term valuation (over years) rather than a trading tool, since rates can deviate from the parity level for years.
Example.

A comparable hypothetical basket costs EUR 100 and USD 120, implying absolute parity of 1.20 USD/EUR. A market rate of 1.10 need not return promptly to 1.20: trade costs, non-traded services and financial flows limit the model.

Absolute and relative parity

Absolute PPP compares basket prices. Relative PPP links longer-term exchange-rate changes to inflation differences. Both require consistent baskets, currencies and quotation direction; a single popular product is a simplification.

Why deviations persist

Transport, taxes, barriers, quality and local services impede arbitrage. Relative productivity and financing can change equilibrium exchange rates. A deviation is not automatically a safely exploitable mispricing.

Useful analysis without false timing

PPP supports purchasing-power comparisons and longer-term scenarios. It supplies neither an entry date, stop loss nor certain target. Financing costs and losses can accumulate long before a hypothetical adjustment.

Primary source checked 11 October 2026: data.imf.org.

FAQ

Is PPP a rate at which currency can be bought?

No. It is a model or statistical comparison, not a guaranteed executable quote.

Is PPP undervaluation sufficient to buy?

No. The model specifies neither timing nor risk control and may omit persistent economic differences.

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Jarosław Wasiński

Editor-in-chief, ForexMechanics.com • Macro & FX analyst

Independent analyst and practitioner with over 20 years of experience in financial markets. Actively involved in Forex since 2007, with a focus on fundamental analysis, OTC market structure, and disciplined capital risk management.

  • Creator and editor-in-chief of MyBank.pl, providing reliable financial education since 2004.
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