According to the purchasing power parity theory, which of the following is most likely to affect exchange rates?

Question

Quizplus · Accepted Answer

The purchasing power parity theory suggests that exchange rates will adjust to equalize the price of a basket of goods and services across countries. Inflation rates directly affect the price level in a country, so differences in inflation rates between two countries will affect exchange rates. As inflation rises in one country, the purchasing power of the local currency decreases, which means that the currency becomes less valuable, leading to a decline in its exchange rate relative to other currencies. Therefore, differences in inflation rates are most likely to affect exchange rates. Differences in interest rates, income levels, and real GDP growth rates may also have some impact on exchange rates, but their influence may be less direct than inflation rates.

According to the Purchasing Power Parity Theory, Which of the Following