Question

Based on purchasing power parity theory, should the Mexican Peso appreciate or depreciate? Please provide ample justification

Answer 1

Answer:-

Purchasing power parity (PPP) is defined as the price of a good in one country is equal to its price in another country, after adjusting for the exchange rate between the two countries. This relationship often does not hold in reality because of many factors.

PPP also states that there will be parity among prices for the same good in all countries which is the law of one price.

.The recent depreciation in the peso versus the dollar was temporary but it bounced back as high interest rates in Mexico which will attract investors who look for good returns.

The recent inflation number of 3.95 in June 2019 compared to 4.28 percent in the previous month is within the target inflation set by one percentage point above or below the inflation of 3%. Considering the policy interest rate which is 8.25% as of June 2019 and PPP makes mexico an attractive investment which will cause the appreciation of the peso against in the short term.As per the data from January 2008 to June 2019 the policy interest rate is at peak level at 8.25% compare to its lowest level of 3 % in November 2015.

The recent financial instability may be short-lived and will not impact the currency to a larger extent.The prudent fiscal policy may only help the Peso to appreciate in the long run as well.