Assume that U.S. annual inflation equals 8 percent, while Japanese annual inflation equals 5 percent. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of:
A) appreciation of the yen's value over the next year.
B) depreciation of the yen's value over the next year.
C) no change in the yen's value over the next year.
D) Information about interest rates is needed to answer this question.

Question

Quizplus · Accepted Answer

According to the purchasing power parity (PPP) theory, the currency of the country with a higher inflation rate is expected to depreciate relative to the currency of the country with a lower inflation rate. In this scenario, since the U.S. has a higher inflation rate (8%) compared to Japan (5%), the PPP theory would forecast an appreciation of the yen's value over the next year.

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