Purchasing Power Parity Parity and Interest Rate Parity

Purchasing Power Parity Parity and Interest Rate ParityBefore discussing the theories underlying the research is, parity Purchasing Power Parity and Interest Rate will be explained first understanding of currency exchange rates, inflation and interest rates.A. Currency Exchange1. Understanding Exchange RateCurrency exchange rate is the value or price of a currency exchange with another country's currency is defined or occur in conjunction with Latu cross interstate trade and monetary policies. Negma money each has a price which is measured by the money of other countries.This is what is called the exchange rate (Ir. BurhanuddinAbdullah, translation Lindert and Kindleberger 1995:336.) Exchange rates within a certain period may be tidakberubah from time to time, but generally in the eye uangselalu tukm value change due to influence demand for eye danpenawaran money.2. Factors Affecting Currency Exchange RatesThere are several factors affecting high and low exchange rates of foreign currencies to local currency. These factors are:a. Relative InflationThe increase in inflation which a country makes the price of domestic goods become more expensive, will increase that demand in the country in which foreign goods have lower inflation rates, and therefore will also increase domestic demand on foreign currency. This can increase the value of domestic currency against foreign currencies.b. Relative Interest RatesCountries with a higher interest rate will look more attractive to investors than countries with low interest rates. With the excess money and interest to the investment, investors will increase demand on the country currency interest rates higher.This will increase the country's currency exchange rate which is lower sukubunganya the country against foreign currency interest rates are higher.c. Relative Income LevelThe increase in revenues relative level of a country against other countries will increase demand in these countries goods in other countries. This can cause the increasing demand of foreign currency.d. GovernmentCan affect exchange rates through policies, for example: trade barriers in overseas markets to foreign exchange intervention.e. Interaction between factorsFactors that influence the exchange rate can interact. For example, changes in differences in inflation may affect interest rate differentials. This could be a material consideration for foreign investors who will invest their money.
B. Inflation
Inflation adala s Uatu circumstances in which the constantly increasing prices in general or a state where a decline in the value of money. This is due to the increasing amount of money circulating in masyarakat.Kenaikan price in one or two types of goods can not be called inflation. The increase in prices caused by factors such as season, ahead of major holidays or the teradi just once can not be called inflation.
C. Interest Rates
What is meant by the interest rate is the price of using money for a specified period (Boediono, 1999: 75). Understanding interest rates as prices can also be expressed as a price to be paid in case of an exchange between an amountnow with an amount in the future.An interest rate increase, when the amount of money in circulation smaller than the demand for money. Instead interest rates will decline if the amount of money in circulation is greater than the demand for money.
D. Purchasing Power Parity
Purchasing power parity is a relationship between the price of goods and services with foreign currency exchange rates (Mr. Burhanuddin Abdullah, translation Lindert and Kindleberger, 1995: 356). Purchasing Power Parity is a model that explains how the current exchange rate tends to adjust to the difference in the rate of inflation.
1. Absolute Purchasing Power Parity
Absolute Purchasing Power Parity states the relationship between the prices of goods and services with foreign currency exchange rates with the following equation:E = P
            PfE is the exchange rate (domestic currency per unit foreign currency), P is the domestic price index and Pf is the price index abroad. To get the price index, prices should be determined in advance of the goods and services to be monitored. Then the prices of various goods and services are determined bobotnya.Indeks price is the weighted average of prices of goods and services-description is researched.The equation above shows that the exchange rate or money between two countries is equal to the ratio of price index between the two country dapad equation described as follows:
            P = Early Pregnancy FactorThis equation is called the Law of One Price and showing that the goods sold for the same price worldwide.



2. Relative Purchasing Power Parity
Absolute Purchasing Power Parity In addition, there are other reviews about Purhasing Power Parity, the relative purchasing power parity, expressed by the following equation:
       ^ ^E = P-Pf
where the hat sign (^) above the variable indicates the percentage change. So the equation above states bahwapersentase changes in currency exchange rates is equal to the percentage change in domestic price level less the Percentage change in price level abroad.In general the percentage change in price level is expressed as the rate of inflation. So to declare Relative Purchasing Power Parity in other ways is that the percentage difference in exchange rate equal to the difference in domestic inflation with abroad.
E. Interest Rate Parity
Interest Rate Parity is a theory that suggests that there is a relationship between the rate of depreciation of a country's currency against the currencies of other countries with the determination of interest rates.Interest Rate Parity arising from arbitrage activities to seek profit (profit) in particular Covered Interest Rate. As an example is as follows;I $: interest rates in the United StatesI £: Interest rates in BritainF: Forward Exchange Rate (Dollars per pound)E: Spot Exchanger ate (Dollars per Pound)In this case the interest rate and forward rate has a maturity that sama.Seorang investors in the United States can obtain 1 + l $ in the country by investing dollars for a single period. Investors can also invest money in the UK by swapping its currency to the pound. So that after a period investors can obtain (1 + I,) / E pounds. pounds obtained will then be converted again in Dollars. However, due to currency exchange rates in the future are not known for certain, investors can be overcome by carrying forward contract to sell (l + Ir) / E £ it in the foreseeablecome at a certain dollar value.Thus investors can obtain l + Is the dollar by investing 1 dollar in the domestic or obtain (1 + Ir) F / E of dollars by investing dollars in the UK. Arbitration Between two such investment opportunity would generate:1 + I $ = (1 + I £) F
                             EWhich can be written as follows:
            1 + I $ F
            1 + I £ EFrom the equation it can produce an Interest Rate Parity equation by using a 1 from both sides, is as follows:
            I $ + I £ - F - E
            1 + I £ EWhich sometimes becomes:
            I $ - I £ = F - E
                              E
F. Argumentation Theory
Purchasing Power Parity Theory menyatakan.bahwa inflation rate can affect currency exchange rates. Interest Rate Parity Theory states that interest rates can affect currency exchange rates.Based on the theory of Purchasing Power Parity and Interest Rate Parity theory, the rate of inflation and interest rates in a country have the effect of currency exchange rates.Both of these factors can interact, giving rise to a greater influence on currency exchange rates. For example, changes in inflation differences can affect the rate differential bunga.Dengan a change in inflation and interest rate differences, the exchange rate will tend to adjust to the situation.