At the beginning of 2003 the AUD/USD exchange rate was 1.7662. At the same time, the forecast change in the AUD/USD in 2003 was 2.00% and the forecast inflation rate for the US in 2003 was 1.50%. What should be the forecast inflation rate for Australia in 2003, according to PPP theory?
A) 3.53%
B) 0.50%
C) -0.50%
D) -3.50%

Question

Quizplus · Accepted Answer

According to the Purchasing Power Parity (PPP) theory, the change in the exchange rate between two currencies over a period of time should approximately equal the difference in inflation rates between those two countries. Given the forecast change in the AUD/USD exchange rate is 2.00% and the forecast inflation rate for the US is 1.50%, the forecast inflation rate for Australia should be the sum of these two percentages: 2.00% + 1.50% = 3.50%. Therefore, the correct answer is 3.53%, which is closest to the calculated value.

At the Beginning of 2003 the AUD/USD Exchange Rate Was