The principle that the change in the bilateral exchange rate should be equal to the difference in the national inflation rates is known as:
A) the MacPPP standard.
B) absolute PPP.
C) relative PPP.
D) arbitrage.
E) the interest parity condition.

Question

Quizplus · Accepted Answer

Relative Purchasing Power Parity (PPP) holds that the rate of depreciation of a currency is equal to the difference in inflation rates between two countries. This principle suggests that countries with higher inflation rates should see their currency depreciate relative to countries with lower inflation rates, to maintain the purchasing power of currencies. Absolute PPP, on the other hand, refers to the idea that in the absence of transportation and other transaction costs, identical goods in different countries should have the same price when expressed in a common currency.

The Principle That the Change in the Bilateral Exchange Rate