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PPP and Exchange Rates
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Understanding the factors that affect levels of economic and social development in countries, and monitoring poverty reduction at the global level requires measures that convert indicators such as GDP and other economic statistics measured in national currencies, into a common accounting unit, typically the United States Dollar. Because market exchange rates are based on short-term factors and are subject to substantial distortions from speculative movements and government interventions, comparisons based on exchange rates, even when averaged over a period of time such as a year, yield unreliable and misleading results.
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The problems associated with comparing indicators of social and economic development across countries have been known for some time, as have the shortcomings associated with the use of exchange rate conversion factors. Indeed it was the recognition of these problems by the international community in the sixties that first gave rise to the ICP, with a view to generating PPP data. By establishing purchasing power equivalence, where one dollar purchases the same quantity of goods and services in all countries, PPP conversions allow cross-country comparisons of economic aggregates on the basis of physical levels of output, free of price and exchange rate distortions.
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