5.5 Relative prices and exchange rates
See Table 5.5 hereAbout the data
Definitions
Data sources
Prices measured relative to the overall price level or in relation to other prices in the economy provide vital information to the three main economic agents: households, producers, and the government. In a market-based economy the decisions of these agents about the allocation of resources are influenced by relative prices, and relative prices reflect, to a large extent, the choices of these agents. Thus relative prices—the real exchange rate, real wages, real interest rates, and relative commodity prices—convey vital information about the interaction of economic agents in an economy and in relation to the rest of the world, at a given point in time as well as over time.
The exchange rate is the relative price of a currency in terms of another currency. Official exchange rates are established by governments. Parallel, or "black market," exchange rates reflect rates negotiated by traders and are by their nature difficult to measure reliably. Parallel exchange rate markets often account for only a small share of transactions and may therefore be both thin and volatile. The parallel rates reported here are collected by Currency Data & Intelligence, Inc. from a variety of sources, some within the country and some outside but doing business with entities based in the country. The sources include import-export firms, banknote collectors trading with local partners, and other business travelers. For currencies that are heavily restricted from free trade and transferability, the "black market" rate is used. For currencies with little or no exchange restrictions but which trade at rates that differ slightly from the rates fixed by government banking institutions or rates observed in official interbank channels, "free market" rates are used. For currencies for which multiple rates exist, the rates are averaged to derive an estimate applicable to unofficial transfers.
Real effective exchange rates are derived by deflating a trade-weighted average of the nominal exchange rates that apply between trading partners. For most industrial countries the weights are based on trade in manufactured goods with other industrial countries and an index of relative, normalized unit labor costs is used as the deflator. For other countries the weights take into account trade in manufactured and primary products during 1980–82 and an index of relative changes in consumer prices is used as the deflator. An increase in the real effective exchange rate represents an appreciation of the local currency. Because of conceptual and data limitations, movements in real effective exchange rates should be interpreted with considerable caution.
Purchasing power parity (PPP) conversion factors are based on surveys of the comparative purchasing power of currencies by the United Nations International Comparison Programme (ICP). The conversion factors can be treated as an exchange rate relative to the "international dollar," a common currency or unit of account that equalizes price levels in all economies. It has the same purchasing power over total GNP as the U.S. dollar in a given year. (For further discussion of the PPP conversion factor see the notes to table 4.14.)
Many interest rates exist in an economy, reflecting differences in creditors, debtors, the terms governing loans and deposits, and competitive conditions. In some economies interest rates may be set by administrative action or regulation. In economies with imperfect markets or where reported nominal rates are not indicative of the effective rates, it may be difficult to obtain data on interest rates that reflect actual market transactions. The deposit and lending rates in the table are collected by the International Monetary Fund (IMF) as representative interest rates offered by banks to resident customers; however, the terms and conditions attached to these rates differ from country to country. Real interest rates are calculated by adjusting nominal rates by an estimate of the rate of inflation in the economy. A negative real interest rate indicates a loss in the purchasing power of the principal. The real interest rates in the table are calculated as (i – P) /(1 + P), where i is the nominal interest rate and P is the rate of inflation.
Domestic prices for two key agricultural commodities, wheat and maize, show that prices often are not equalized across international markets (even after adjusting for freight, transport, insurance, and differences in quality). Market imperfections, such as taxes, subsidies, and trade barriers, drive a wedge between domestic and international prices. Commodity prices in local currency are converted into U.S. dollars using official, period average exchange rates.
• Official exchange rate is an annual average based on exchange rates (local currency units to U.S. dollars) determined by country authorities, or rates determined largely by market forces in the legally sanctioned exchange market.
• Ratio of official to parallel exchange rate measures the premium people must pay to exchange the domestic currency for dollars in the black market relative to the official exchange rate.
• Real effective exchange rate is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs.
• Purchasing power parity conversion factor is the number of units of a country's currency required to buy the same amounts of goods and services in the domestic market as one dollar would buy in the United States.
• Deposit interest rate is the rate paid by commercial or similar banks for demand, time, or savings deposits.
• Lending interest rate is the rate charged by banks on loans to prime customers.
• Real interest rate is the deposit interest rate adjusted for inflation as measured by the GDP deflator.
• Key agricultural producer prices are the domestic producer prices per metric ton for wheat and maize converted to U.S. dollars using the official exchange rate.
Official and real effective exchange rates are from the IMF's International Financial Statistics. Estimates of parallel market exchange rates are from Currency Data & Intelligence, Inc.'s Global Currency Report. PPP conversion factors are from ICP and World Bank staff estimates. Deposit and lending interest rates are from the IMF's International Financial Statistics. Real interest rates are calculated using World Bank data on the GDP deflator. Agricultural price data are compiled by the Food and Agriculture Organization (FAO) and published in its Production Yearbook. The IMF and the FAO provide the World Bank with electronic data files that are usually more up-to-date than the print publications cited here.
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