Let the United States endure an inflation rate of 10 percent in some year during which the rest of the world saw inflation of only 5 percent. The theory of purchasing power parity would predict, in that case, that the dollar should

Question

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The theory of purchasing power parity (PPP) suggests that in the long run, exchange rates will adjust so that the same basket of goods costs the same in different countries. If the US experiences a higher inflation rate (10%) than the rest of the world (5%), it means that goods in the US are becoming relatively more expensive compared to goods in the rest of the world. Therefore, to restore purchasing power parity, the value of the dollar should decrease, or depreciate, relative to other currencies. The correct answer is that the dollar should depreciate by the difference in inflation rates, which is 5%.

Let the United States Endure an Inflation Rate of 10