Which factors can alter the Purchasing Power Parity (PPP) relationship?

The Purchasing Power Parity (PPP) relationship can indeed be influenced by several factors, and differential interest rates along with central bank intervention are key elements in this context. PPP is based on the idea that in the long run, exchange rates between currencies adjust so that the same basket of goods costs the same in different countries. However, this ideal scenario can be disrupted by various economic factors.

Differential interest rates can affect capital flows between countries, leading to changes in exchange rates and thus impacting the PPP relationship. For example, if one country has higher interest rates compared to another, it may attract foreign capital, appreciating its currency. This, in turn, can affect the relative pricing of goods and services, thereby altering the purchasing power parity.

Central bank intervention can also play a significant role in altering the PPP. Central banks may intervene in foreign exchange markets to stabilize or influence their currency's value, which can distort the natural adjustments that would occur according to PPP.

In contrast, while changes in trade policies, economic growth rates, or currency denomination changes can impact economic conditions and currency valuations, they do not directly manipulate the fundamental relationship described by PPP as effectively as interest rates and central bank actions. Therefore, focusing on interest rates and central bank interventions provides a more