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Unformatted text preview: Implied July against currency Jan. 4, PPP correct currency dollars by PPP 13th dollar, % per U.S. $) 2010 or not? (1) (2) (3) (4) (5) United States $ 3.57 3.57 Australia A$ 4.34 3.3643 1.2157 1.29 –5.76% 0.90 –30.23% Correct direction, but depreciation was way more than predicted. Brazil R$ 8.03 4.0150 2.2493 2 12.46% 1.74 –13.00% PPP predicted depreciation, but currency actually appreciated. Canada C$ 3.89 3.3534 1.0896 1.16 –6.07% 1.04 –10.34% Correct direction, but appreciation was way more than PPP predicted. Denmark Kr 29.50 5.5243 8.2633 5.34 54.74% 5.17 –3.18% PPP predicted [ic] depreciation, but currency actually appreciated. Euro area ⇔ 3.31 4.5972 0.9272 0.72 28.77% 0.69 –4.17% PPP predicted depreciation, but currency actually appreciated. Japan ¥ 320.00 3.4557 89.6359 92.6 –3.20% 93.05 0.49% PPP predicted appreciation, but currency actually depreciated. Mexico Peso 33.00 2.3913 9.2437 13.8 –33.02% 12.92 –6.38% Correct direction, but appreciation was way less than PPP predicted. Sweden Kr 39.00 4.9367 10.9244 7.9 38.28% 7.14 –9.62% PPP predicted [ic] depreciation, but currency actually appreciated. We can see from the table that during this time, PPP correctly predicted the di- rection exchange rate movements for only three of these countries. The Big Max Index may fail to predict exchange rate movements because there are nontrad- able inputs used in the production of Big Macs, such as labor and rent. 5. You are given the following information. The current dollar- pound exchange rate is $2 per British pound. A U.S. basket that costs $100 would cost $120 in the United Kingdom. For the next year, the Fed is predicted to keep U.S. inflation at 2% and the Bank of England is predicted to keep U.K. inflation at 3%. The speed of convergence to absolute PPP is 15% per year. a. What is the expected U.S. minus U.K. inflation differential for the coming year? Answer: The inflation differential is equal to 2 1% ( 5 2% 2 3%). b. What is the current U.S. real exchange rate, q UK / US , with the United Kingdom? Answer: The current real exchange rate is: q UK / US 5 ( E $/£ P UK )/ P US 5 $120/$100 5 1.2. c. How much is the dollar overvalued/undervalued? Answer: The British pound is undervalued by 20% and the U.S. dollar is over- valued by 20% ( 5 1.2 2 1 / 1). d. What do you predict the U.S. real exchange rate with the United Kingdom will be in one year’s time? Answer: We can use the information on convergence to compute the implied change in the U.S. real exchange rate. We know the speed of convergence to ab- solute PPP is 15%; that is, each year the exchange rate will adjust by 15% of what is needed to achieve the real exchange rate equal to 1 (assuming prices in each country remain unchanged). Today, the real exchange rate is equal to 1.2, imply- ing a 0.2 decrease is needed to satisfy absolute PPP. Over the next year, 15% of this adjustment will occur, so the real exchange rate will decrease by 0.03. There- fore, after one year, the U.S. real exchange rate, q UK/US , will equal 1.17....
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- Winter '13
- Exchange Rate, japan, Foreign exchange market, United States dollar