Assume that U.S. annual inflation equals 8 percent, while Japanese annual inflation equals 5 percent. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of:
A)appreciation of yen's value over the next year.
B)depreciation of yen's value over the next year.
C)no change in yen's value over the next year.
D)information about interest rates is needed to answer this question.

Question

Assume that U.S. annual inflation equals 8 percent, while Japanese annual inflation equals 5 percent. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of:​
A)appreciation of yen's value over the next year.
B)depreciation of yen's value over the next year.
C)no change in yen's value over the next year.
D)information about interest rates is needed to answer this question.

Quizplus · Accepted Answer

According to the purchasing power parity (PPP) theory, the currency of the country with a higher inflation rate is expected to depreciate. Since the U.S. has a higher inflation rate (8%) compared to Japan (5%), the PPP theory would forecast an appreciation of the yen's value over the next year.

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