The triangular purchasing power parity hypothesis: A comment

• Date: 01 March 2021
• DOI: http://doi.org/10.1111/twec.13050
• Published date: 01 March 2021
• Author: Alan King

World Econ. 2021;44:837–848. wileyonlinelibrary.com/journal/twec

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837

© 2020 John Wiley & Sons Ltd

Received: 18 March 2019

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Accepted: 1 October 2020

DOI: 10.1111/twec.13050

ORIGINAL ARTICLE

The triangular purchasing power parity hypothesis:

A comment

AlanKing

Department of Economics, University of Otago, Dunedin, New Zealand

KEYWORDS

China, pegged exchange rate, purchasing power parity

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INTRODUCTION

Wang and Liu (2018) recently proposed a triangular purchasing power parity (PPP) hypothesis that,

they claim, has significant implications for international monetary economics, finance and business.

Specifically, they argue that (a) the gravity and momentum of the Chinese economy, (b) the curren-

cies chosen to invoice trade transactions between the world’s three largest economies and (c) the de

facto peg of the renminbi (RMB) to the US dollar create a triangular PPP effect whereby the exchange

rate between the euro and the US dollar becomes a function of China’s price level relative to that of

Euroland. Under this hypothesis, and in contrast to the conventional PPP relationship, the US price

level plays no role in the determination of the dollar–euro exchange rate.

The purpose of this paper is to demonstrate Wang and Liu’s (2018) argument is flawed and that tri-

angular PPP is nothing more than a rearrangement of the standard PPP relationship between Euroland

and China. This is why the US price variable is absent; the standard theory of PPP would not expect

it to be present in this context. In short, Wang and Liu’s (2018) hypothesis offers no new insights.

The remainder of the paper is structured as follows: Section2 outlines Wang and Liu’s (2018)

theoretical framework for the triangular PPP relationship and summarises their empirical evidence.

This framework and evidence are evaluated in Section3. Section4 summarises the main points and

concludes the paper.

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THE THEORETICAL FRAMEWORK FOR

TRIANGULAR PPP

2.1

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Motivation

Wang and Liu (2018) (hereafter, WL) use the existing empirical evidence on PPP (and, in particular,

that presented by Cashin & McDermott,2006; Sarno & Valente,2006) to motivate their work. They