Question16 According to PPP, if inflation is higher in Australia than in Japan (all else equal): Select one alternative: The Australian dollar will appreciate relative to the Japanese yen None of the answers above is correct The Australian dollar will be unchanged, as PPP is determined by interest rate differentials. The Australian dollar will depreciate relative to the Japanese yen ResetMaximum marks: 2 Flag question undefined

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BlackTom AI · Accepted Answer

To begin, let's lay out what PPP (purchasing power parity) says in this context: if domestic inflation in Australia is higher than inflation in Japan, then the Australian price level rises relative to Japan's. This tends to weaken the Australian dollar against the Japanese yen, since a higher domestic inflation corresponds to a depreciation of the currency to restore parity in purchasing power.
Option 1 states that the Australian dollar will appreciate relative to the Japanese yen. This contradicts PPP reasoning under higher Australian inflation, so this choice is incorrect.
Option 2 asserts that none of the answers above is correct. Given the PPP implication discussed, there is a correct statement among the options, so this is not accurate.
Option 3 claims that the Australian dollar will be unchanged because PPP is determined by interest rate differentials. This mixes up two different theories: PPP relates to price levels and inflation, not directly to relative interest rates. This makes the option misleading and incorrect.
Option 4 says the Australian dollar will depreciate relative to the Japanese yen. This aligns with PPP when Australia’s inflation is higher, since higher domestic inflation tends to reduce the currency’s value compared to a country with lower inflation. This option is consistent with the PPP framework and the given condition.
In summary, the reasoning matches option 4 as the statement consistent with PPP under higher Australian inflation, while the other options conflict with PPP principles or misinterpret the determinants of exchange rate movements.

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