An American (USA) car currently costs $18,000 while the equivalent United Kingdom (UK) car costs £10,000. The nominal UK interest rate is 8 per cent and the nominal US interest rate is 5 per cent. The interest rate in the two countries is equal at 2 per cent and the nominal interest rate differential is full explained by expected inflation differentials. (i) Determine the current Purchasing Power Parity (PPP) exchange rate measured as dollars per pound. (ii) Assuming that international investors are risk neutral, calculate the percentage by which the pound is expected to appreciate or depreciate against the dollar. (ii) If the actual inflation rate coincides with the expected inflation rate and absolute purchasing power p holds on a continuous basis, calculate the PPP exchange rate measured as dollars per pound in one time.
An American (USA) car currently costs $18,000 while the equivalent United Kingdom (UK) car costs £10,000. The nominal UK interest rate is 8 per cent and the nominal US interest rate is 5 per cent. The interest rate in the two countries is equal at 2 per cent and the nominal interest rate differential is full explained by expected inflation differentials. (i) Determine the current Purchasing Power Parity (PPP) exchange rate measured as dollars per pound. (ii) Assuming that international investors are risk neutral, calculate the percentage by which the pound is expected to appreciate or depreciate against the dollar. (ii) If the actual inflation rate coincides with the expected inflation rate and absolute purchasing power p holds on a continuous basis, calculate the PPP exchange rate measured as dollars per pound in one time.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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