In the field of international economics and finance, the concept of Purchasing Power Parity (PPP) has been among the most enduring. Absolute PPP (which is in its ultimate form) indicates that on condition that a common currency dominates prices, people could purchase the same commodity anywhere for the same price. The law of one price provides certain theoretical guidance for the concept, assuming that arbitrage in many types of commodities equalizes prices. After the gold standard collapse during World War I, Cassel (1922) suggested that relative gold parities could be restored by using PPP. He said that post-war exchange rates were set by countries in terms of PPP by making sure that the change in their post-war and pre-war exchange rates was equal to the difference between their post-war and pre-war inflation rates. Since then, PPP has been used by economists to set and predict exchange rates, in adjusting cross-country incomes to explain differences in prices, and as a foundation of models in international macroeconomics.
Purchasing Power Parity was firstly proposed as a short-run equilibrium by large numbers of international economists in the first few years after the collapse of the Bretton Woods system in the early 1970s. It was then attacked from both theoretical and empirical aspects during the late 1970s through the mid-1990s. As a result, over the last three decades, a large literature has built up that examines the deviation between data and theory, and the research achievements have offered a more profound understanding of the application of PPP in both the short run and the long run. Since the mid-1990s, larger datasets and nonlinear econometric methods have specially met the need of improving forecast accuracy: The gap narrowed between theory and data with the narrowed deviations between real exchange rates and PPP, and some degree of confidence in long-run PPP began to emerge again. The idea of long-run PPP now getting perhaps its most powerful support in more than thirty years shows a radical reversion in economic thought in this regard.