Assume the initial yen/dollar exchange rate to be 100 yen per dollar.If the U.S.inflation rate is 2 percent and the Japanese inflation rate is 7 percent,the exchange rate should move to 105 yen per dollar according to the purchasing-power-parity theory.

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Quizplus · Accepted Answer

According to the purchasing-power-parity theory, the exchange rate should move in the direction of the inflation differential, meaning that the yen should weaken relative to the dollar due to the higher Japanese inflation rate. Therefore, the exchange rate should move to 95 yen per dollar, not 105 yen per dollar.

Assume the Initial Yen/dollar Exchange Rate to Be 100 Yen