Suppose the inflation rate over the last 20 years has been 10 per cent in SA, 7 per cent in Japan, and 3 per cent in the USA.If purchasing power parity holds, which of the following statements is true? Over this period,
A)the value of the dollar should have fallen compared to the value of the rand and the yen.
B)None of these answers.
C)the yen should have fallen in value compared to the rand and risen compared to the dollar.
D)the value of the rand should have risen compared to the value of the yen and the dollar.
E)the yen should have risen in value compared to the rand and fallen compared to the dollar.

Question

Quizplus · Accepted Answer

According to the theory of purchasing power parity, the exchange rate between two currencies should adjust such that the same basket of goods costs the same in both currencies. If the inflation rate in one country is higher than in another, its currency should depreciate over time to restore parity. Therefore, since Japan has had a lower inflation rate than South Africa and the USA, the yen should have appreciated in value compared to both currencies. On the other hand, the rand has had a higher inflation rate than both the yen and the dollar, so its value should have depreciated compared to both currencies. Thus, option E is the only one that accurately reflects the expected exchange rate movements.

Suppose the Inflation Rate Over the Last 20 Years Has