Describe and explain the relationship between expected inflation rates in two countries and their interest rate...
Describe and explain the relationship between expected inflation rates in two countries and their interest rate differential according to the PPP theory.
Homework Answers
As per PPP Theory, when one country's inflation rate rises relative to another country, it results into increasing import and decreasing exports and hence depresses home country's currency.
However as per International Fischer effect, currencies with higher interest rate will depreciate.
Hence from both above theories we can conclude that depreciation of home country's currency will lead to higher interest rates and higher inflation.
Hence higher interest rate or an Interest rste differential directly corresponds to higher inflation.
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Describe and explain the relationship between expected inflation rates in two countries and their interest rate...
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