Assume the initial dollar/pound exchange rate to be $2 per pound.If the U.S.inflation rate is 8 percent and the U.K.inflation rate is 3 percent,the exchange rate should move to $2.10 per pound according to the purchasing-power-parity theory.

Question

Quizplus · Accepted Answer

According to the purchasing-power-parity theory, the exchange rate should adjust to reflect the relative changes in inflation rates. Since the U.S. has a higher inflation rate than the U.K., the dollar should depreciate relative to the pound, causing the exchange rate to move from $2 to $2.10 per pound. Therefore, the statement is true.

Assume the Initial Dollar/pound Exchange Rate to Be $2 Per