The purchasing power parity theory is a reasonably good explanation for nominal exchange rate determination

Question

Quizplus · Accepted Answer

Purchasing power parity theory suggests that exchange rates should adjust over time to equalize the prices of identical goods and services in different countries, taking into account the exchange rate. This is more likely to hold true in the long run between countries with very different inflation rates, as opposed to the short run or when there are significant volumes of non-traded goods and services. The theory also assumes that there are no barriers to trade and that goods are freely traded. Additionally, the theory may not hold true for international trade in non-standardized goods and services, and is not applicable when there are fixed exchange rates.

The Purchasing Power Parity Theory Is a Reasonably Good Explanation