6. Assume that purchasing power parity holds real exchange rates close to E(Ca)1

Question

6. Assume that purchasing power parity holds real exchange rates close to E(Ca)1 a. The nom exchange rate e(EUR/JPY) is increasing. Where is inflation hisher2 b. The nom exchange rate e(CAD/JPY) is decreasing. Where is inflation hisher? c. Using the information in a and b, where is inflation highest? Europe or Canada or Japan? 3 EC 202 Name 7. Assume that prices adjust slowly, so that purchasing power does not hold even for easily tradable baskets. a. The US dollar depreciates relative to the Canadian dollar. Goods are getting cheaper in b. The Japanese Yen appreciates relative to the Chinese Yuan. Goods are getting cheaper in , what is the effect on US Net Exports? (increase or decrease) What is the effect on Japanese Net exports? (increase or decrease

Explanation / Answer

6) - a) - The nominal exchange rate is increasing, thus, 1 EUR can buy more JPY as compared to earlier. That means, more amount of JPY is needed to buy the same basket of goods than EUR. Thus, inflation is increasing in JPY. Therefore, Inflation is higher in JPY

6) - b) - The nominal exchange rate is decreasing, thus, 1 CAD can buy less JPY as compared to earlier. That means, less amount of JPY is needed to buy the same basket of goods than CAD. Thus, inflation is increasing in CAD. Therefore, Inflation is increasing in CAD

6) - c) - Comparing all 3, we get that Inflation is higher in JPY as compared to EUR, but inflation is higher in CAD as compared to JPY. Thus, inflation is highest in CAD

7) - a) - US dollar depreciates relative to Canadian dollar means that now less amount of Canadian dollar can be purchased with 1 US dollar as compared to before. This means that goods are getting cheaper in US. Since, more amount of dollar will be required to purchase same amount of Canadian dollars, import will decrease and export will rise in US. Thus, US Net Exports will increase.

7) - b) - Japanese Yen appreciates relative to Chinese Yuan means that now more amount of Chinese Yuan can be purchased with 1 Japanese Yen as compared to before. This meas that goods are getting cheaper in China. Since, with more amount of Chinese Yuan can be purchased with 1 Japanese Yen, export will rise in China and import will rise in Japanese Yen from China. Thus, Japanese Net exports will decrease.

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