A triangular purchasing power parity hypothesis

Abstract

We propose a triangular PPP analytical framework, which is theoretically justified and empirically validated. The mechanisms and channels through which a seemingly mystery relationship emerges are deliberated and examined, which renders significant implications to international monetary economics, finance and business. The de facto peg of the RMB to the US dollar, together with trade activities and arrangements, causes a triangular PPP effect that the dollar euro exchange rate is not a function of the relative prices in the US and Euroland. Instead, it becomes a function of the relative prices in the PRC and Euroland. The results are supportive of triangular PPP in a three-economy world of the US, Euroland and PRC.