a. If the inflation rate in Australia is higher than the inflation rate in the U

Question

a. If the inflation rate in Australia is higher than the inflation rate in the United States. Using the purchasing power parity theory determine the expected impact on the domestic currency to US$ exchange rate.

TO ANSWER QUESTION

CHOOSE ONLY TWO ANSWERS FROM THE LIST BELOW

Select one or more:

(i) PPP exchange rate will decrease

(i) PPP exchange rate will increase

(ii) domestic currency will depreciate

(ii) domestic currency will appreciate

(ii) domestic currency will devalue

(ii) domestic currency will revalue

b. Identify whether your country has a fixed or flexible exchange rate regime and indicate whether a change in your country’s currency would be due to devaluation or depreciation.

c. What is the difference between depreciation and devaluation?

Explanation / Answer

(a) If the inflation rate in Australia is higher than the inflation rate in the United States. Using the purchasing power parity theory, the expected impact on the domestic currency to US$ exchange rate will be as follows:

(i) PPP exchange rate will decrease

(ii) Domestic currency will depreciate

b) India has a floating exchange rate regime since 1992, as having a floating rate system gives you more flexibility to respond to needs of the economy. Floating exchange rate regimes let the forces of supply and demand decide the exchange rate of the economy, without any government intervention.
Thus, a change in the country's currency would be due to Depreciation and not Devaluation.

c) Devaluation happens in countries with a fixed exchange rate. In a fixed-rate economy, the government decides what its currency should be worth compared with that of other countries.
On the other hand, Depreciation happens in countries with a floating exchange rate. A floating exchange rate means that the global investment market determines the value of a country's currency, and is usually free of government intervention.

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