The inflation rate in the United States is 4 percent, while the inflation rate in Japan is 1.5 percent. The current exchange rate for the Japanese yen (¥) is $0.0080. After supply and demand for the Japanese yen have adjusted according to purchasing power parity, the new exchange rate for the yen will be:

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, countries with high inflation rates will experience depreciation in their currency values, while countries with low inflation rates will experience appreciation in their currency values. Therefore, the Japanese yen will appreciate relative to the US dollar. The percentage difference in inflation rates is (4-1.5)/100 = 0.025. Therefore, the percentage change in the exchange rate will be approximately 0.025. The current exchange rate is ¥0.0080 = $0.0080. Thus, the new exchange rate will be approximately $0.0080 + ($0.0080 x 0.025) = $0.0082. Therefore, the answer is B.

The Inflation Rate in the United States Is 4 Percent