If people expect relative PPP to hold
A) the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected, in the United States and Europe, respectively, over the relevant horizon.
B) the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected in Europe and the United States, respectively.
C) the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected, over the relevant horizon, in the United States and Europe, respectively, in the short run.
D) the difference between the interest rates offered by dollar and euro deposits will be above the difference between the inflation rates expected, over the relevant horizon, in the United States and Europe, respectively.
E) the difference between the interest rates offered by dollar and euro deposits will be below the difference between the inflation rates expected, over the relevant horizon, in the United States and Europe, respectively.

Question

Quizplus · Accepted Answer

Relative Purchasing Power Parity (PPP) suggests that the rate at which the exchange rate between two currencies will change over time is equal to the difference in their inflation rates. Therefore, if people expect relative PPP to hold, they would anticipate that the difference between the interest rates in two countries (e.g., offered by dollar and euro deposits) reflects the expected difference in inflation rates between those two countries (e.g., the United States and Europe). This is because interest rates generally incorporate expectations about inflation, among other factors.

If People Expect Relative PPP to Hold