2. Relative purchasing power parity Aa Aa E According to the law of one price, after adjusting for exchange rates, identical products should sell for same price in all countries. This relationship states that prices and exchange rates between two countries move to a level where a basket of goods will have the same price in the two countries. This form of law of one price is called: Absolute purchasing power parity Relative purchasing power parity Suppose you need to forecast the one-year forward rate between the euro and the U.S. dollar. Based on your research, you expect inflation in the eurozone to be 2.8% next year, whereas inflation in the United States is expected to remain at 1.4% in the coming year. The current spot rate between the two regions can be represented as $1 = 0.6506. Based on the information you have, your estimate of the one-year future spot rate-if you consider the United States as your home country-is Therefore, the higher inflation rate in the eurozone can be expected to lead to a decline in the future spot value of the euro relative to the dollar by The relative purchasing power parity relationship is stronger for countries with: Low inflation rates High inflation rates 2. Relative purchasing power parity Aa Aa E According to the law of one price, after adjusting for exchange rates, identical products should sell for same price in all countries. This relationship states that prices and exchange rates between two countries move to a level where a basket of goods will have the same price in the two countries. This form of law of one price is called: Absolute purchasing power parity Relative purchasing power parity Suppose you need to forecast the one-year forward rate between the euro and the U.S. dollar. Based on your research, you expect inflation in the eurozone to be 2.8% next year, whereas inflation in the United States is expected to remain at 1.4% in the coming year. The current spot rate between the two regions can be represented as $1 = 0.6506. Based on the information you have, your estimate of the one-year future spot rate-if you consider the United States as your home country-is Therefore, the higher inflation rate in the eurozone can be expected to lead to a decline in the future spot value of the euro relative to the dollar by The relative purchasing power parity relationship is stronger for countries with: Low inflation rates High inflation rates