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I am trying to calculate which currencies are 'cheaper' or more 'expensive' than others over the long term. As such, I am trying to calculate a Real Exchange Rate (RER) to which exchange rates should converge over the long run. See this article. I am using the purchasing power parity data from the OECD (found here) to stand in for where rates should gravitate toward over time. Purchasing power parity is only released once a year so its needs to be adjusted for inflation (found here). I was wondering how exactly purchasing power parity is adjusted by inflation to calculate the Real Exchange Rate. Is it simply the PPP value times the ratio of inflation rates between the two countries? For example, from the data linked above, the UK had a PPP ratio of 0.68 (rounded) to the United States in 2022. Do we then multiply this by the ratio of the UK's inflation rate over the US's inflation rate for Q1 (UK: 9.4%, US: 5.8%), Q2 (UK: 7.7%, US: 4.0%), Q3 ... for 2023. So would this be: 2022 PPP * (2023 Q1 inflation ratio) * (2023 Q2 inflation ratio). 0.68 * (1.09 / 1.058) * (1.077 / 1.04) for the current adjusted PPP ratio between these two countries? We then take the ratio of this to the current market price to arrive at the Real Exchange Rate I believe.

Thanks for any help or pointers.

David Frick
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  • I don't know where you are getting these numbers. But be careful that US 5.8% is probably quarterly inflation expressed at an annual rate (i.e 4 quarters' worth of inflation!). It is not the rise in prices for Q1. Or it could be YoY inflation, again an annual figure. – noob2 Sep 20 '23 at 12:56
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    I am getting them from the OECD, see the links. I selected change since last period to avoid YoY figures. – David Frick Sep 20 '23 at 13:31

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