ECON476_PS3_Solutions.pdf - ECON 476 International...

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ECON 476: International Macroeconomics Spring 2020 Problem Set #3 Solutions S ECTION 1: S HORT A NSWER Q UESTIONS 1. Suppose Russias inflation rate is 100 percent over one year but the inflation rate in Switzer- land is only 5 percent. According to relative PPP, what should happen over the year to the Swiss francs exchange rate against the Russian ruble?
2. Answer the following questions related to PPP: (a) Explain why exchange rate model based on PPP is a long run theory. (b) Present and explain the Fundamental Equation of the Monetary Approach. (c) Discuss the effects of ongoing inflation based on the PPP theory. Answer:
And according to relative PPP: E $ / d ,t /E $ / d ,t - 1 - 1 = π US,t - π E,t If people expect relative PPP to hold, the difference between interest rates offered by dollar and euro deposits will equal the difference between the expected inflation rates, over the relative horizon, in the U.S. and Europe.

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