If the annual inflation rate is 5.5 percent in the United States and 4 percent in the U.K.,and the dollar depreciated against the pound by 3 percent,then the real exchange rate,assuming that PPP initially held,is:

Question

Quizplus · Accepted Answer

The real exchange rate is calculated by adjusting the nominal exchange rate for inflation differentials. With a 5.5% inflation rate in the US and 4% in the UK, the inflation differential is 1.5%. The nominal depreciation of the dollar is 3%. The real exchange rate change is 3% - 1.5% = 1.5% depreciation, so the real exchange rate is approximately 0.98, indicating a slight depreciation.

If the Annual Inflation Rate Is 5