The purchasing power parity theory has limitations in forecasting exchange rate fluctuations for all of the following reasons except ?
Correct answer: A. inflation effects exchange rates
- A. inflation effects exchange rates
- B. international capital flows affect exchange rates
- C. governments sometimes impose trade restrictions such as tariffs and quotas
- D. not all products are internationally tradeable
Explanation
Inflation differentials are the central basis of purchasing power parity, so inflation affecting exchange rates is not a limitation of the theory. Capital flows, trade restrictions, and non-tradable goods can make actual exchange rates depart from PPP.
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