Can average exchange rates be used as proxies for PPPs?
PPP converted GDPs make better economic sense than do exchange rate converted GDPs. Exchange rate fluctuations can make it appear that countries have suddenly become “richer” or “poorer” even though in reality there has been no change in the volumes of goods and services produced. A moving average of exchange rates does not provide a more plausible picture. For example, if we consider the GDP for Japan as a percentage of that for the USA in 1985, 1990, 1993, 1996 and 1999, the PPP-converted data show a fairly steady relationship between the GDP for the two countries, which is to be expected given that the rates of growth in their GDP were not hugely different over these years. On the other hand, the exchange rate converted data show changes in the relationship of GDP between the two countries which are economically implausible. Even using a 5-year moving average of the exchange rates does not improve the plausibility of the relationship significantly.
