If inflation in the U.S. is projected at 5% annually for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot rate is currently at L2400 = $1, then the PPP estimate of the spot rate five years from now is

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Quizplus · Accepted Answer

The PPP estimates that the spot rate in 5 years will change in proportion to the inflation difference between the two countries. The inflation difference = (12% - 5%) = 7%. Therefore, the PPP estimate of the spot rate in 5 years = (2400)(1.07)^5 = 3314.

If Inflation in the U