he domestic price level in one of the two countries should result in a proportionate depreciation of the exchange rate between the two countries. The restrictive character of the absolute PPP hypothesis is such that even if it were possible to construct prices in the manner suggested by the hypothesis, the existence of transportation costs and other impediments to trade would interfere with the functioning of the hypothesized process. An assumption that such factors remain constant over time, however, permits the absolute purchasing power parity hypothesis to work.
The PPP hypothesis states that the percentage exchange rate depreciation is equal to the difference between domestic inflation and foreign inflation. A restructuring of the hypothesis states that the change in the real exchange rate, conditional on relative PPP holding, will result in the logarithmic real exchange rate change equaling zero (Faruqee, 1995).
Long-run analyses tend to support the PPP hypothesis; howeve
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