ABSTRACT
Of the many influences on exchange rates one factor is considered to be particularly important for explaining currency movements over the long run. That factor is inflation. In this chapter we examine the theory and the evidence for a long-run connection between inflation and exchange rates. This connection has become known as the purchasing-power parity (PPP) principle. An entire chapter is devoted to the exploration of this principle because it plays an important role in foreign exchange risk and exposure, as well as many other topics covered in the remainder of this book.
