The basis of this theory is the nominalistic and quantitative theory of money. The founders of this idea were the English economists D.Yum and D. Ricardo. The latter argued that the low cost of pounds sterling led to a trade deficit: “… the export of a coin is caused by its cheapness and is not a consequence, but a cause of an unfavorable balance. In his opinion, the depreciation of money is “a consequence of their excess”, and the ratio of the purchasing power of currencies is determined by the amount of money in the circulation of the respective countries. All options are based on this formula. purchasing power parity theory. The essence of this theory boils down to the following: the exchange rate is determined by the relative value of money from different countries, which depends on the price level, which, in turn, on the amount of money in circulation. The main problem of this theory is the search for a equilibrium course that will maintain balance of payments balance. This determines the relationship of this theory with the concept of automatic balance of payments self-regulation.
The most complete theory of purchasing power parity was first justified by Swedish economist G. Kassel in 1918. In his opinion, “in conditions of normal trade, such a exchange rate is established that reflects the ratio between the purchasing power of the respective currencies”. However, despite the convincing argument of the formation of the exchange rate, which is really related to the purchasing power of monetary units, this theory denies the objective value basis of the exchange rate, explaining its formation based on the quantitative theory of money. G. Kassel, and his supporters believe that the alignment of the exchange rate by the purchasing power of currencies occurs freely under the influence of automatically activated factors, i.e. change in exchange rates, affecting cash circulation, loans, prices, the structure of foreign trade and the movement of capital, thus restores the balance.
The development of state regulation revealed the failure of the axiom of automatic equilibrium recovery as a direct consequence of the naturalness of a market economy, which was recognized in 1932 by G. Kassel in connection with the factor of state regulation of international trade. In his opinion, the assertion that parity is determined solely by the level of export and import prices is a “gross mistake”. They should be considered as a “rude rough estimate”.
Further development of the theory of purchasing power parity took into account the understanding of the multifactorial nature of the exchange rate and bringing it into line with the purchasing power of money. Among the factors influencing the exchange rate, trade and currency restrictions imposed by the state, the dynamics of loans and interest rates are noted. J.M. Keynes introduced additional factors: psychological and capital flows. A. Marshall added the concept of lag and elasticity of demand in relation to price (the so-called elastic approach).
Despite this, the theory of determining the exchange rate, as the ratio between the price levels of the two countries, remained predominant in modern Western economic science. So P. Samuelson claims that the change in the ratio of the exchange rate “on other things being equal in proportion to the change in the ratio between our prices and prices abroad”.
Thus, the PPP theory, recognizing purchasing power as the real core of the exchange rate, at the same time rejects its value basis, absolutizing the importance of natural market factors and underestimating state methods of regulating exchange rates and balance of payments.