Suppose that the price of the same basket of goods at time 0 is PC0= 100...

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Finance

Suppose that the price of the same basket of goods at time 0 isPC0= 100 in country C and PD0= 90 in country D, so that theexchange rate is SCD0=10090. Inflation rates are expected to be 10%in country C and 21% in country D, over the foreseeablefuture.Â Â
a) Does PP approximately predict an appreciation or depreciationof currency C?
b) What are the expected price levels in the two countries(i.e., PC1 and PD1 ) and the expected no-arbitrage exchange rate inone period (i.e., SC1 )? (Use the exact
form).
d) What is the expected no-arbitrage exchange rate two-yearsinto the future?

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4.3 Ratings (802 Votes)

a As inflation is lower in country C 10 than country D21 Currency C will appreciate and Currency D will depreciate as lower inflation means a lower loss in value while See Answer

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