Suppose that the spot exchange rate between the Japanese Yen (Y) and the U

Math Feb 27, 2021

Suppose that the spot exchange rate between the Japanese Yen (Y) and the U.S. dollar ($) was Y110/$1 in 1990. Between 1990 and 1995, the consumer price index rose 20% in Japan, and 30% in the U.S. Then what will be the sport exchange rate in 1995 predicted by the Purchasing Power Parity Hypothesis?

Expert Solution

Answer:

r₁ = r_o[(1+π_f)/ (1+π_h)] = (Y110/$1)[(1+0.2)/(1+0.3)] =Y101.538/$1.

That is, $ depreciates, and Y appreciates during the period.

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