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

Question

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Absolute purchasing power parity primarily concerns itself with the relationship between price levels and exchange rates, not directly with interest rates or the growth rate of the nominal exchange rate. However, under the assumption of fixed exchange rates, if absolute purchasing power parity holds, it implies that price levels between two countries adjust to ensure that the purchasing power of currencies remains equal. This does not directly dictate the conditions of home inflation being lower than foreign inflation or the growth rate of the nominal exchange rate being positive. Interest rates can be influenced by purchasing power parity through the international Fisher effect, which suggests that differences in nominal interest rates between two countries will reflect expected changes in the exchange rate between them. However, under fixed exchange rates and absolute PPP, the focus is not on the equality of interest rates but rather on the equality of purchasing power, which indirectly can lead to interest rate parity if capital mobility is assumed.

If Absolute Purchasing Power Parity Holds, Under Fixed Exchange Rates