The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation rate is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, the expected spot rate at the end of one year is $____.
A) 1.02
B) 1.03
C) 1.04
D) None of these are correct.

Question

Quizplus · Accepted Answer

The expected spot rate at the end of one year is $1.04. This is because the purchasing power parity theory states that the exchange rate between two currencies should be equal to the ratio of the price levels in the two countries. In this case, the U.S. inflation rate is expected to be 4 percent, while the European inflation rate is expected to be 3 percent. This means that the price level in the U.S. is expected to increase by 4 percent, while the price level in Europe is expected to increase by 3 percent. As a result, the euro is expected to appreciate against the dollar, and the expected spot rate at the end of one year is $1.04.

The US Inflation Rate Is Expected to Be 4 Percent Over