Considering the theory of purchasing power parity, if inflation in Mexico is 5% while prices in the U.S. are stable; we should expect over the period of a year:
A) the dollar to appreciate 5% relative to the peso.
B) the peso to appreciate 5% relative to the dollar.
C) the nominal exchange rate to stay fixed.
D) the real exchange rate of U.S. goods / Mexican goods to appreciate 5%.

Question

Quizplus · Accepted Answer

DAccording to the theory of purchasing power parity (PPP), if a country experiences higher inflation than another, its currency is expected to depreciate in value relative to the other country's currency. In this scenario, with Mexico experiencing 5% inflation while the U.S. has stable prices, the dollar should appreciate by approximately 5% relative to the peso (A). Additionally, the real exchange rate, which adjusts the nominal exchange rate for price levels, of U.S. goods to Mexican goods would appreciate by 5% (D), reflecting the increased purchasing power of the dollar relative to the peso.

Considering the Theory of Purchasing Power Parity, If Inflation in Mexico