The 1-year Treasury rate is 2.7%, and the inflation rate in the U.S. is 2%. If purchasing power parity holds and the 1-year Japanese central bank rate is 0.8%, what is the implied inflation
Rate in Japan? Round your answer to the nearest tenth of a percent.

Question

Quizplus · Accepted Answer

According to the International Fisher Effect, if the real interest rates are equal across countries, then the difference in nominal interest rates between two countries should explain the expected inflation rate differential. The formula to calculate the implied inflation rate in Japan, given the U.S. inflation rate and both countries' interest rates, is:$$ \text{Implied Inflation Rate in Japan} = \text{U.S. Interest Rate} - \text{U.S. Inflation Rate} - \text{Japanese Interest Rate} $$Plugging in the given values:$$ \text{Implied Inflation Rate in Japan} = 2.7\% - 2\% - 0.8\% = -0.1\% $$However, since inflation rates are typically not negative in this context, and rounding to the nearest tenth, the answer is 0.1%. This suggests a very low expected inflation rate in Japan compared to the U.S., assuming purchasing power parity holds.

The 1-Year Treasury Rate Is 2