106 CHAPTER 3. SPOT MARKETS FOR FOREIGN CURRENCY
Figure 3.14:LogPPPvlog actual rates,HC/USD-20246810-2 0 2 4 6 8 10log PPP ratelog actual rateSourceBased on data fromThe Economist, May 26, 2006
(This explains why there are negative rates: numbers below unit produce negative
logs). There obviously is a very strong link.
DoItYourself problem 3.3
Knowing that the BigMac costs 3.10 in theusand 155 in Freedonia, and that the
spot rate is 100 Crowns per dollar, complete Freedonia’sppprates in the table:
curren-
cylocal
priceactual
value
of $PPP
rate
of $real
rate
of $actual
value
in $PPP
rate
in $real
rate
in $
Freedonia korona 155 100.
But a closer look at the table reveals big relative deviations, which are hard to
spot from a log graph dominated by outliers. Kicking out the 20 highest cases so as
to be able to forego logs, this time, we get Figure 3.15. Note how the observations
tend to be above the equality line (where actual =ppp): the dollar tends to be too
expensive, by BigMacpppstandards. Yet there are also important deviations below
the 45-degree line, where the slope of the ray through the dot is even below 0.5 in
one case. The slope of this ray is called thereal exchange rate, to which we now
turn.