Exchange rate parity (currency parity)
What is exchange rate parity (currency parity)?
Exchange rate parity (currency parity) - the statutory ratio between the two currencies, which is the basis of the exchange rate.
What is the purpose of exchange rate parity?
Parity is the basis for the formation of exchange rates, because it determines their ratio in the order established by law. That is, with the help of parity the ratio of the national currency to the currencies of other states is determined. The parity can be determined with the help of any currency unit.
At the moment there are two modes for the exchange rate:
- fixed exchange rate;
- floating exchange rate.
How did modern currency parity come about?
Until 1978, exchange rate parity was determined by the gold content of currencies, that is, the amount of gold contained in the monetary units of countries. Then, for the countries within the International Monetary Fund (IMF) The basis of calculation became "Special Drawing Rights" (SDRs): a type of international currency used only for intergovernmental settlements through central banks.
Since 1979, the European Monetary Union (EMU) came into force, which began to fix the obligations of the member states of the European Economic Community (EEC) to maintain currency parity within established limits. Among the important factors affecting the currency parity it is necessary to note the state of the balance of trade of countries, the volume of money supply, the rate of inflation growth, the degree of state intervention, etc.
How is currency parity calculated?
In economics, the exchange rate is determined by purchasing power parity. Using this method, exchange rates are obtained conventionally, since there are no exact figures for the consumer basket due to the different structures of goods and services provision in different states. In practice, currency parity is confirmed through long-term planning and calculation of currency parities
Purchasing power parity is a ratio expressing the amount of two or more units of different currencies needed to purchase a particular set of goods and services. The meaning of purchasing power parity is to show how much a set of goods and services is worth in a country expressed in the monetary units of other nations.
This ratio is expressed by a forum:
P = r X Pi or r = P/Pi, where
- Pi and P are the price of a particular consumer basket in the other state and country for which the calculation is made;
- r is an indicator of the exchange rate or the value of the foreign currency used for the calculation.
What is currency parity at ?
On the sub exchange rate parity is understood as the equality in the value of currencies relative to each other. In this case the quotation of such currency pair is equal to one. Example EUR/USD = 1.0000.