Mt2_fall_2007_q2_sol - linearization which the `inflation difference implicitly assumes Answers which are approximate as in my above verbal

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Question 2 Real FX Rate Base Year U.K. U.S. USD/GBP GBP/USD U.K. goods/U.S. goods Price Ratio 2003 213 84 1.90000 0.52632 1.00000 4.81786 2004 220 90 1.97094 0.50737 1.00000 Inflation 3.2864 7.1429 0.0373 diff 3.8565 Nominal Exchange Rates The economic interpretation is that U.K. inflation was 3.27% ({\em i.e.}, 220/213) whereas U.S. inflation was 7.14\%. PPP implies that the U.S. dollar should depreciate by (roughly) the difference in inflation rates, 3.86\%. The appreciation rate on USD is 1.97/1.9 = 3.68%, which is roughly what the inflation difference dictates (the difference is due to
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Unformatted text preview: linearization which the `inflation difference' implicitly assumes). Answers which are approximate --- as in my above verbal explanation --- should be penalized lightly -- 2 marks only. The question, and the associated problem set from which it derives, asks for exact calculations, but approximate ones that show an understanding of the essence of the PPP idea are almost fine. <== this is the ratio of base year prices, P_b/P^*_b...
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This note was uploaded on 01/20/2012 for the course INVESTMENT 101 taught by Professor Unknown during the Spring '08 term at Carnegie Mellon.

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Mt2_fall_2007_q2_sol - linearization which the `inflation difference implicitly assumes Answers which are approximate as in my above verbal

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