In the long run
A) exchange rates obey relative PPP when all disturbances occur in the output markets.
B) exchange rates obey absolute PPP when all disturbances occur in the output markets.
C) exchange rates are unlikely to obey relative PPP when all disturbances occur in the output markets.
D) exchange rates are unlikely to obey relative PPP when all disturbances are monetary in nature.
E) exchange rates obey absolute PPP when all disturbances are monetary in nature.

Question

Quizplus · Accepted Answer

Relative PPP holds that exchange rate changes will be equal and opposite to inflation differentials between two countries. However, if all disturbances occur in the output markets, such as changes in productivity, technology, or preferences, then relative PPP is unlikely to hold in the long run. This is because such changes will affect relative prices and trade patterns, which in turn can cause exchange rates to deviate from PPP. Absolute PPP, which holds that exchange rates will adjust to equalize the cost of a basket of goods across countries, may also be violated in the presence of output market disturbances.

In the Long Run