Suppose, the purchasing power parity holds and real exchange rate remains constant. If the inflation rate in USA is 10% and Canada's inflation rate is 4%, then the nominal exchange rate of US dollar will:
A) decrease by approximately 10%
B) increase by approximately 10%
C) decrease by approximately 6%
D) increase by approximately 6%

Question

Quizplus · Accepted Answer

According to the relative purchasing power parity, the nominal exchange rate change is approximately equal to the difference in inflation rates between the two countries. Here, the US inflation rate is 10% and Canada's is 4%, so the nominal exchange rate of the US dollar will decrease by approximately 6% (10% - 4%).

Suppose, the Purchasing Power Parity Holds and Real Exchange Rate