Theoretical origins and evolution of the Purchasing Power Parity theory in Cassel’s economic thought
In this article we review the main aspects underlying the development of the Purchasing Power Parity (PPP) theory by Swedish economist Gustav Cassel. In particular we review claims put forward by commentators such as Moosa (1999) and Kardochnikov (2013) that modern presentations of the PPP are wrongly attributed to Cassel’s work. In the view of it’s originator the PPP was never seen as an arbitrage condition, a generalization of the Law of One Price, but rather an extension of the Quantity Theory of Money (QTM) to an open economy context. However, when reviewing Cassel’s writings regarding the QTM in an economy with credit it is revealed a connection between what Cassel (1922) dubbed creation of “artificial purchasing power” and the Wicksell’s theory of interest and prices, in which the difference between market and natural interest rate is key to explain fluctuations of prices. Furthermore, contrary to some expositions that describe Cassel’s formulation of the PPP as a naïve theory of exchange rate determination, it is important to highlight that across the years Cassel noted himself many of the possible reasons why exchange rate would differ from PPP both in the short-run and in the long-run. Concomitant with these caveats, progressively introduced by Cassel in his writings in the early 1920’s, there is a shift in his focus and application of the PPP. In these later texts Cassel’s main use of the PPP was on a more normative stance, in which the PPP would consist of an objective guide to calculate new gold parities in the post-war period and, thus, contribute to the stabilization of the international monetary system and resuming international trade conditions prevailing during the war.
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Keywords: Purchating Power Parity, Gustav Cassel, Quantity Theory Of Money, Wicksell
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