The Mexican economy is predicted to average double-digit inflation over the next two years at 10% per year.The inflation forecast for the U.S.for the same period is 4% per year.If the current exchange rate is $0.091/peso,what is the expected exchange rate two years from now?

Question

Quizplus · Accepted Answer

Using the purchasing power parity theory, the exchange rate can be calculated as follows:
Expected exchange rate = Current exchange rate * (1 + Mexican inflation rate) / (1 + US inflation rate)
Expected exchange rate = 0.091 * (1 + 0.1)^2 / (1 + 0.04)^2
Expected exchange rate = 0.091 * 1.21 / 1.1664
Expected exchange rate = 0.0947 or $0.08134/peso (rounded to 5 decimal places)

The Mexican Economy Is Predicted to Average Double-Digit Inflation Over