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Dear Moffat,
Hope you are fine and thank you for your lectures. Would you please help me on the bellow question:
I know that by using the purchasing power parity (PPP) formula we can PREDICT the future spot rate and PPP formula uses INFLATION rates of the two countries.
And by using the money market hedge (MMH) technique we can CALCULATE the FORWARD exchange rate and MMH uses INTEREST rates of the two countries.
I am completely OK with the above terms.
But my question is why we can NOT use:
INTEREST rates to PREDICT the future spot rate ? or
INFLATION rates to CALCULATE the FORWARD exchange rate?!!Because according to 4-way equivalence model (fisher formula) interest rate and inflation rate are linked!! So why these statements are wrong?
Thank you very much
Kind regardsIn theory, in the long-term, using interest rates or inflation rates would give the same result.
However in practice and in the short-term, this may not be the case.
Interest rates are always used to calculate forward rates. Inflation rates are regarded as a better predictor of future spot rates (but only a predictor because in practice many other factors will affect the spot rate).
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