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Suppose Russia’s inflation rate is 100 percent over one year but the inflation rate in Switzerland...

Suppose Russia’s inflation rate is 100 percent over one year but the inflation rate in Switzerland is only 5 percent. According to relative PPP, what should happen over the year to Swiss franc’s exchange rate against the Russian ruble?

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Relative PPP predicts that inflation differentials are matched by percentage change in the exchange rate. Under relative PPP, the franc/ruble exchange rate would fall by 95%. That is, the franc is expected to appreciate against the ruble by 95%

Relative PPP predicts that inflation differentials are matched by changes in the exchange rate.

Given, Inflation rate in country

S = 100%

Inflation rate in country R = 5%

Calculate the inflation differential as follows:

Inflation differentials =100%-5%

= 95%

Thus, the inflation differential is 95% = change in ruble/franc exchange rate

Under relative PPP, the ruble is expected to depreciate by 95%.

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