The U.S. rate of inflation is projected at 2% per year over the next ten years, while the Japanese rate of inflation is projected at 0% per year. The current exchange rate is 121 yen/$. 

 

a)  If you do not think the dollar is currently overvalued or undervalued against the yen, what is the exchange rate ten years hence predicted by purchasing power parity?

b)  If you think the dollar is overvalued by 30% in real terms against the yen, what exchange rate would you predict 10 years hence? Assume that misevaluations have an expected half-life of 5 years.