Suppose the inflation rate in Japan is 0.4% and the inflation rate in the U.S. i

Question

Suppose the inflation rate in Japan is 0.4% and the inflation rate in the U.S. is 2%. Which of the following statements is INCORRECT based on the PPP theory?

There is a currency depreciation from the U.S. perspective based on the changes in the nominal exchange rate.

There is a currency appreciation from the U.S. perspective based on the changes in the nominal exchange rate.

There can be a currency appreciation going on in reality.

There is not enough information to tell if there is a currency depreciation or currency appreciation based on the real exchange rate.  

There is a currency depreciation from the U.S. perspective based on the changes in the nominal exchange rate.

There is a currency appreciation from the U.S. perspective based on the changes in the nominal exchange rate.

There can be a currency appreciation going on in reality.

There is not enough information to tell if there is a currency depreciation or currency appreciation based on the real exchange rate.  

Explanation / Answer

PPP theory relates inflation rates to the exchange rates

The change in the inflation rate can be related to the change in exchange rates and then the depreciation or appreciation of a currency can be determined.

In the question given, only inflation rates are given . We cannot determine the change in inflation rates.

Therefore,

There is not enough information to tell if there is a currency depreciation or curency appreciation based on the real exchange rate

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