If the U.S. inflation rate is expected to be 3 percent next year, the European inflation rate is expected to be 4% next year, and the spot rate between the euro and dollar is $1.30, then according to purchasing power parity, we would expect the dollar to _________ against the euro from $1.30 to __________.

Question

Quizplus · Accepted Answer

According to the purchasing power parity (PPP) theory, if the U.S. inflation rate is lower than the European inflation rate, the dollar should appreciate relative to the euro. The expected new exchange rate can be calculated using the formula: New rate = Spot rate * (1 + home inflation rate) / (1 + foreign inflation rate) = 1.30 * (1 + 0.03) / (1 + 0.04) = $1.2875.

If the US Inflation Rate Is Expected to Be 3 Percent Next