The purchasing power parity hypothesis implies that an increase in inflation in one country relative to another will over a long period of time
A) increase exports
B) reduce the competitive pressure on prices
C) lower the value of the currency in the country with the higher inflation rate
D) increase foreign aid
E) increase the speculative demand for the currency

Question

Quizplus · Accepted Answer

The purchasing power parity hypothesis suggests that the exchange rate between two currencies should adjust to equalize the prices of a basket of goods and services in each country. If one country experiences higher inflation than the other, it means that its prices are rising faster. This should lead to a depreciation in the value of its currency to restore its competitiveness in the global market. Hence, the correct option is C, lower the value of the currency in the country with the higher inflation rate.

The Purchasing Power Parity Hypothesis Implies That an Increase in Inflation