IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses
India's inflation rate is persistently higher than that of its main trading partners, with a floating exchange rate and no other changes. According to purchasing power parity, what is the expected long-run movement of the rupee and its effect on exporters?
The rupee is expected to depreciate, roughly by the inflation differential, which tends to offset the competitiveness lost through higher domestic prices. Under purchasing power parity, real exchange rates stay broadly constant in the long run.
- AThe rupee depreciates, which tends to offset the loss of price competitiveness from higher domestic inflationCorrect
- BThe rupee appreciates, which improves exporters' competitiveness
- CThe rupee stays fixed because PPP applies only to fixed rates
- DThe rupee depreciates, which permanently worsens exporters' competitiveness
- The rupee appreciates, which offsets the higher inflation in importers' costs
Explanation
PPP says the currency of the higher-inflation country depreciates by roughly the inflation differential, keeping real exchange rates constant. This offsets the competitiveness loss. Appreciation would widen the loss.
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