If the rate of inflation is suddenly expected to be 7% higher in the US than in the UK,and higher than previously anticipated,the dollar should immediately depreciate by 9 percent with respect to the pound in order to keep prices equal in the US and the UK.

Question

Quizplus · Accepted Answer

The immediate depreciation of the dollar by a specific percentage such as 9% due to expected inflation differences does not directly follow from economic theory. The actual exchange rate movement would depend on various factors including market perceptions, interest rate differentials, and how these inflation expectations are incorporated into currency values. The Purchasing Power Parity (PPP) theory suggests that currencies adjust to offset inflation differentials over the long term, but the immediate and exact percentage change cannot be determined solely by the change in inflation expectations.

If the Rate of Inflation Is Suddenly Expected to Be