Has the Spike in Inflation Volatility over the Past Few Years Changed Equilibrium Exchange Rates?

One way to estimate the long‑run equilibrium exchange rate is to compare price levels in different countries. In general, over the long term, exchange rates should gradually adjust so that prices in different countries are equal when expressed in the same currency. This is called purchasing power parity (PPP). Since the pandemic, inflation has become more volatile, and this has likely changed the long‑run equilibrium exchange rate for certain currency pairs. In this Economic Viewpoint, we’ll look at how this might affect our exchange rate forecasts for the currencies of major advanced economies.