IGNOU IBO 6 2026 - Explain the theory of purchasing power parity (PPP) and interest rate

Question

Explain the theory of purchasing power parity (PPP) and interest rate parity (IRP). Critically evaluate their relevance in determining exchange rates in the modern financial environment.

12 Feb 2026

Answer :

Word Count : 617

Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) are two critical theories used to understand exchange rate movements in international finance. These theories, while helpful in theory, have been subject to criticism due to their limited applicability in today's global financial markets. PPP suggests that in an efficient market, the exchange rate between two currencies will adjust to reflect changes in the price level of each country. According to the theory, a basket of goods in one country should cost the same in another country once the exchange rate has been adjusted for. This means that if the inflation rate in one country is higher than in another, the currency of the country with higher inflation should depreciate, bringing the price of

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