Suspension of international trading and financial activities/ Macroeconomics
Large scale wars typically bring a suspension of international trading and financial activities. Exchange rates lose much of their relevance under these conditions, but once the war is over, governments wishing to determine the rate at which to fix their exchange rates face a problem of what the new rates will be. The PPP theory has often been applied to this problem of postwar exchange rate realignment. Imagine that you are a British Chancellor of the Exchequer and that World War I just ended. Explain how you would figure out the dollar/pound exchange rate implied by the PPP. When might it be a bad idea to use the PPP theory in this way? [Hint: UK’s productive capacity decreased considerably during the war].
