If absolute purchasing power parity holds, under fixed exchange rates:

Question

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Absolute purchasing power parity states that the price of identical goods should be the same in different countries when expressed in a common currency. This means that if the exchange rate between two currencies is fixed, the home inflation rate and the foreign inflation rate should be equal for the exchange rate to remain fixed. If the inflation rate in the home country is higher than the inflation rate in the foreign country, home currency will depreciate (lose value) and foreign currency will appreciate (gain value) until inflation rates equalize. Similarly, if the home interest rate is higher than the foreign interest rate, investors will move their funds to the foreign country, resulting in a decrease in demand for the home currency, and causing the home currency to depreciate until the interest rates equalize. Thus, all three options A, B, and C must hold for absolute purchasing power parity to hold under fixed exchange rates.

If Absolute Purchasing Power Parity Holds, Under Fixed Exchange Rates