Understanding Purchasing Power Parity

Very Easy Currency Exchange Rates Parity Conditions

In the realm of international finance, various conditions influence currency exchange rates. One of the essential concepts in this area is that of parity conditions, which help to predict the relationship between exchange rates and economic factors such as interest rates and inflation.

Which of the following statements correctly describes a fundamental aspect of purchasing power parity (PPP)?

PPP states that in the long run, exchange rates should reflect the relative prices of a basket of goods.

PPP holds only in the short term due to market inefficiencies.

PPP explains currency fluctuations caused by changes in foreign exchange reserves.

Hint

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