Question

3. how do you reconcile the high level of interest rates in Thailand with the expected change of the baht dollar exchange rate according to PPP?

Answer 1

One possible way to determine whether PPP holds between two countries is to regress historical exchange rate changes on the inflation differential between two countries. However, this form of testing whether PPP holds is not appropriate for Thailand, since the baht has only been freely floating for a short period of time; when the baht was pegged to the dollar, the baht-dollar exchange rate was not affected by the inflation rates in the two countries.

One possible alternative is to investigate, via regression analysis, whether PPP holds between the U.S. and a country similar to Thailand in terms of inflation rates, other economic characteristics, and trade relationships with the U.S. The regression results could then be used to assess how the baht-dollar exchange rate may be affected by the inflation differential between the U.S. and Thailand in the future.

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