Question

Explain why, in order to preserve the purchasing power parity (PPP), a country with a higher inflation should have its currency depreciate against currencies of countries with lower inflation, all else equal (including real rates of interest in different countries).

Answer 1

According to purchasing power parity exchange rate between two currencies is depend on inflation rate between two countries. inflation rate in one country is higher than other country then it’s currency will depreciate against other currency.

If Inflation rate in one country is higher and then price of goods and services increases at faster rate than a country with lower inflation rate. So, to equalte the price of product or service, exchange rate with higher inflation country depreciate.