Question 1. Explain the theory of purchasing power parity (PPP). Based on this theory, what is a general forecast of the values of currencies in countries with high inflation?
Question 2. Explain the rationale of the PPP theory.
Question 3. Explain how you could determine whether PPP exists. Describe a limitation in testing whether PPP holds.
Question 4. Inflation differentials between the U.S. and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the corresponding currencies have changed by 10 percent or more. What does this information suggest about PPP?
Question 5. Explain why PPP does not hold.