Editing Purchasing power parity (section)

==History==

The idea can be traced to the 16th-century [[School of Salamanca]]. In [[Paper Credit|1802]], [[Henry Thornton (reformer)|Henry Thornton]] "was the first economist to clearly explain the operation of the self-adjusting mechanism that keeps the exchange rate close to its purchasing power par". In [https://www.columbia.edu/cu/lweb/digital/collections/cul/texts/ldpd_8039051_001/ 1807], [https://www.hetwebsite.net/het/profiles/wheatley.htm John Wheatley] "extended" Thornton's analysis, producing an "extreme monetarist version of the PPP doctrine", which was "adhered to" by [[David Ricardo]], [[Walter Boyd (financier)|Walter Boyd]], and the "famous ''[https://babel.hathitrust.org/cgi/pt?id=mdp.39015016711999 Bullion Report]'' (1810)".<ref>{{Cite web |title=The Purchasing Power Parity Doctrine {{!}} Richmond Fed |url=https://www.richmondfed.org/publications/research/economic_review/1979/er650301 |access-date=2025-04-22 |website=www.richmondfed.org |language=en-us}}</ref> In [[The Theory of Money and Credit|1912]], [[Ludwig von Mises]] "provided a modern 'purchasing power parity' theory of exchange rates".<ref>{{Cite web |date=2014-01-07 |title=Lawrence White, |url=https://oll.libertyfund.org/publications/liberty-matters/2014-01-07-lawrence-white-ludwig-von-mises-s-the-theory-of-money-and-credit-at-101-january-2014 |access-date=2025-04-22 |website=oll.libertyfund.org}}</ref> In [[iarchive:goodbadtradeinqu00hawtuoft|1913]], [[Ralph George Hawtrey|Ralph Hawtrey]] gave a "a terse, and precise, statement of the purchasing-power-parity doctrine."<ref>{{Cite book |last=Glasner |first=David |url=https://books.google.com/books?id=rPBLEAAAQBAJ&pg=PA275 |title=Studies in the History of Monetary Theory: Controversies and Clarifications |date=2021-11-01 |publisher=Springer Nature |isbn=978-3-030-83426-5 |language=en}}</ref>

In spite of the above antecedents, [[Gustav Cassel]] is often credited for developing the idea of PPP, especially in his [https://www.jstor.org/stable/2222038 two] [https://www.jstor.org/stable/2221918 1916] ''Economic Journal'' papers, both titled "The Present Situation of the Foreign Exchanges". In 1918, he introduced the phrase "purchasing power parity" in "[https://www.jstor.org/stable/2223329 Abnormal Deviations in International Exchanges]" (also in ''The Economic Journal'').<ref>{{cite journal|last=Cassel|first=Gustav|date=December 1918|title=Abnormal Deviations in International Exchanges|journal=The Economic Journal|volume= 28|issue=112|pages=413–415|jstor=2223329|doi=10.2307/2223329|url=https://zenodo.org/record/1759129}}</ref><ref name="princetonenc">{{cite encyclopedia |last=Cheung |first=Yin-Wong|editor-last=Reinert|editor-first=Kenneth A.|editor2-last=Rajan |editor2-first=Ramkishen S.|editor3-last=Glass|editor3-first=Amy Jocelyn|editor4-first=Lewis S. |display-editors = 3 |editor4-last=Davis|title=purchasing power parity|encyclopedia=The Princeton Encyclopedia of the World Economy|url=https://books.google.com/books?id=BnEDno1hTegC&pg=PA942|access-date=2 October 2011|volume=I|year=2009|publisher=Princeton University Press |location=Princeton |isbn=978-0-691-12812-2 |page=942}}</ref> While Gustav Cassel's use of PPP concept has been traditionally interpreted as his attempt to formulate a positive theory of exchange rate determination, the policy and theoretical context in which Cassel wrote about exchange rates suggests different interpretation.&nbsp;In the years immediately preceding the end of WWI and following it economists and politicians were involved in discussions on possible ways of restoring the [[gold standard]], which would automatically restore the system of [[Fixed exchange-rate system|fixed exchange rates]] among participating nations.<ref name="10.1080_09672567.2013.824999">{{Cite journal|last=Kadochnikov|first=Denis|date=2013|title=Gustav Cassel's purchasing power parity doctrine in the context of his views on international economic policy coordination|journal=European Journal of the History of Economic Thought|volume=20|issue=6|pages=1101–1121|doi=10.1080/09672567.2013.824999|s2cid=154383662}}</ref>

The stability of exchange rates was widely believed to be crucial for restoring the international trade and for its further stable and balanced growth.&nbsp;Nobody then was mentally prepared for the idea that flexible exchange rates determined by market forces do not necessarily cause chaos and instability in the peaceful time (and that is what the abandoning of the gold standard during the war was blamed for). Gustav Cassel was among those who supported the idea of restoring the gold standard, although with some alterations.&nbsp;The question, which Gustav Cassel tried to answer in his works written during that period, was not how exchange rates are determined in the free market, but rather how to determine the appropriate level at which exchange rates were to be fixed during the restoration of the system of fixed exchange rates.<ref  name="10.1080_09672567.2013.824999"/>

His recommendation was to fix exchange rates at the level corresponding to the PPP, as he believed that this would prevent trade imbalances between trading nations.&nbsp;Thus, PPP doctrine proposed by Cassel was not really a positive (descriptive) theory of exchange rate determination (as Cassel was perfectly aware of numerous factors that prevent exchange rates from stabilizing at PPP level if allowed to float), but rather a normative (prescriptive) policy advice, formulated in the context of discussions on returning to the gold standard.<ref name="10.1080_09672567.2013.824999"/>