A column in the New York Times discussed estimates by the International Monetary Fund (IMF) of growth in total world output, or GDP. The column noted that after adding up the value of each country’s output in terms of that country’s currency, the IMF could have converted each total into dollars using the current exchange rate between that country’s currency and the U.S. dollar. The column further noted, though, that there was a significant problem with that approach:
“The International Monetary Fund’s solution to this problem is to use a formula involving purchasing power parity or P.P.P., which adjusts for the relative value of currencies and their purchasing power.” What is the problem with calculating world GDP by converting each country’s output to dollars using current exchange rates? Why would using exchange rates adjusted for the purchasing power of each country’s currency be a better approach?