PS-4 - Spring 2016-Intt 212 Problem Set 4 Please try to...

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Spring 2016-Intt 212 - Problem Set 4 Please try to solve the problems on your own and check your answers with the following ones: End of Chapter 16 problems: 1-8 Answers: 1. Relative PPP predicts that inflation differentials are matched by changes in the exchange rate. Under relative PPP, the franc/ruble exchange rate would fall by 95 percent with inflation rates of 100 percent in Russia and 5 percent in Switzerland. 2. A real currency appreciation may result from an increase in the demand for nontraded goods relative to tradables, which would cause an appreciation of the exchange rate because the increase in the demand for nontradables raises their price, raising the domestic price level and causing the currency to appreciate. In this case, exporters are indeed hurt. Real currency appreciation may occur for different reasons, however, with different implications for exporters’ incomes. A shift in foreign demand in favor of domestic exports will both appreciate the domestic currency in real terms and benefit exporters. Similarly, productivity growth in exports is likely to benefit exporters while causing a real currency appreciation. If we consider a ceterus paribus increase in the real exchange rate, this is typically bad for exporters as their exports are now more expensive to foreigners, which may reduce foreign export demand. In general, though, we need to know
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