The concept of Purchasing Power Parity (PPP) is based on the law of one price, where in the absence of transaction costs and official trade barriers, identical goods will have the same price in different markets when the prices are expressed in the same currency.
The well known Big Mac Index from the Economist magazine is an example of one measure of the law of one price, which underlies purchasing power parity. The Index is used to measure the amount a county’s currency is under or over valued based on the assumption that a Big Mac costs the same in different countries when each countries prices are converted into a single currency, the US dollar.
A newly released working paper considers the question of does PPP hold, not for the modern economies of the world which the Big Mac Index considers, but for the economies of medieval Europe. The results of the study are such that the researchers conclude that medieval financial markets were so well functioning that PPP did hold.
The paper is Did Purchasing Power Parity Hold in Medieval Europe? by Adrian R. Bell, Chris Brooks and Tony K Moore. The abstract for the paper reads:
This paper employs a unique, hand-collected dataset of exchange rates for five major currencies (the lira of Barcelona, the pound sterling of England, the pond groot of Flanders, the florin of Florence and the livre tournois of France) to consider whether the law of one price and purchasing power parity held in Europe during the late fourteenth and early fifteenth centuries. Using single series and panel unit root and stationarity tests on ten real exchange rates between 1383 and 1411, we show that the parity relationship held for the pound sterling and some of the Florentine florin series individually and for almost all of the groups that we investigate. Our findings add to the weight of evidence that trading and arbitrage activities stopped currencies deviating permanently from fair values and that the medieval financial markets were well functioning. This supports the results reported in other recent studies which indicate that many elements of modern economic theories can be traced back over 700 years in Europe.