The current spot rate between the UK and Australia is AUD$1 = £0.6764.The expected inflation rate in Australia is 1.8 per cent.The expected inflation rate in the UK is 3.4 per cent.If relative purchasing power parity exists,what will the exchange rate be 2 years from now?

Question

Quizplus · Accepted Answer

According to relative purchasing power parity, the exchange rate will adjust based on the inflation differential. The formula is: Future Exchange Rate = Current Exchange Rate * (1 + Inflation Rate of Domestic Country) / (1 + Inflation Rate of Foreign Country). Applying this: £0.6764 * (1 + 0.034)^2 / (1 + 0.018)^2 = £0.6982.

The Current Spot Rate Between the UK and Australia Is