Given a home country and foreign country , purchasing power parity (ppp) suggest

Question

Given a home country and foreign country , purchasing power parity (ppp) suggests that: A)a home currency will depreciated if the current home interest rate exceeds the current foreign interests rate. B) a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate C) a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. D) a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate. Given a home country and foreign country , purchasing power parity (ppp) suggests that: A)a home currency will depreciated if the current home interest rate exceeds the current foreign interests rate. B) a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate C) a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. D) a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate. A)a home currency will depreciated if the current home interest rate exceeds the current foreign interests rate. B) a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate C) a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. D) a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

Explanation / Answer

As per the purchasing power parity, the rate of exchange is the one that allows a specific amount of currency in one country to purchase the same quantity of goods in another country.

Now, if the inflation rate at the home country is more than the inflation rate in the foreign country, it will mean that the buying power of the home currency will decline. Secondly, the high inflation rates will also reduce the  perceived desirability if holding the home country's currency vis a vis the currency of the foreign country. Both these factors will result in a decline in the value of the home currency and the demand for the foreign currency will increase.

Hence the answer is "d" -   a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

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