According to purchasing power parity, a rise in inflation in the United States. relative to the rest of the world will lead to
A) an exchange rate appreciation.
B) an exchange rate depreciation.
C) a balance of payments deficit.
D) a balance of payments surplus.

Question

Quizplus · Accepted Answer

According to purchasing power parity, a rise in inflation in the United States relative to the rest of the world will lead to a decrease in the relative value of the US dollar. This means that the exchange rate will depreciate, making US goods relatively cheaper for foreign buyers and foreign goods relatively more expensive for US buyers. This would help to offset the inflationary pressures in the US and reduce the trade deficit. Therefore, the correct choice is (B) an exchange rate depreciation.

According to Purchasing Power Parity, a Rise in Inflation in the United