Can someone explain this or is the answer key incorrect? In a table, we’re given China’s 2011 inflation rate of 4.1%. The question is:
If the inflation rate in the U.S. at the end of 2011 was 3.5%, using relative purchasing power parity, the approximate change in China’s exchange rate is closest to:
A. 0.6%
B. 0.2%
C. -0.6%
The answer key says it’s A, listing the inflation differential as: I(FC) - I(DC) = 4.1% - 3.5% = 0.6%. Shouldn’t the answer, however, be C? China has higher inflation, which would indicate less purchasing power and a decline in the exchange rate.
Any help would be greatly appreciated. Good luck, everyone!
this one got me as well. they are asking for the change in “china’s exchange rate” which is not the same as the value of the chinese currency. i don’t remember the counter-currency, but check the vignette: the exchange rate is expressed as x/Yuan, so if yuan depreciates the exchange rate increases (lower denominator)
Okay. I see what you’re saying about the exchange rate vs. value. My vignette, however, shows Renminbi/Yaun (RMB) per USD. USD would be the denominator, no?
I agree. It is easy to understand “china’s exchange rate” as $/chw; however,there must be some thing else in the vignette to point out that DC= USD, which would correctly indicate that quote is chw/USD
If it takes 20 units of the chinese currency to buy a basket of good that costs 10 units of U.S. currency, then the price level is 20/10 = 2.0. A year later due o inflation, the same basket now has this price level: 20*1.041/10*1.035=2.0116…that comes to about +0.6% increase. So, the relative PPP exchange rate (not currency) has appreciated by about +0.6%.