Question

Using the inflation differential of two countries to forecast their exchange rate is not always accurate because a. Data used to measure relative prices of two countries is almost always accurate. b. The inflation differential is the only factor affecting exchange rates. c. Trade patterns emerging in accordance with PPP theory are rarely disrupted by barriers to trade. d. The timing of the impact of inflation fluctuations on exchange rates is not known with certainty.

Answer 1

Using the inflation differential of two countries to forecast their exchange rate is not always accurate because the timing of the impact of inflation fluctuations on exchange rates is not known with certainty.

Therefore correct answer is option d. The timing of the impact of inflation fluctuations on exchange rates is not known with certainty.

Other influential factors that the inflation differential of two countries to forecast their exchange rate is not always accurate because

• Data used to measure relative prices of two countries may be partly inaccurate.
• The inflation differential is one of the many factors affecting exchange rates.
• Trade patterns emerging in accordance with PPP theory can be disrupted by barriers to trade.