You are given the following information. The current dollar-pound exchange rate
ID: 2737883 • Letter: Y
Question
You are given the following information. The current dollar-pound exchange rate is $2 per pound. A U.S. basket that costs $100 would cost $120 in the United Kingdom. For the next year, the Fed is predicted to keep U.S. in?ation at 2% and the Bank of England is predicted to keep U.S. in?ation at 3%. The speed of convergence to absolute PPP is 15% per year. What is the expected U.S. minus U.K. in?ation differential for the coming year? What is the current U.S. real exchange rate qus.UK with the United Kingdom? How much is the dollar overvalued/undervalued? What do you predict the U.S. real exchange rate with the United Kingdom will be in one year's time? What is the expected rate of real depreciation for the United States (versus the United Kingdom)? f. What is the expected rate of nominal depreciation for the United States (versus the United Kingdom)? g. What do you predict will be the dollar price of one pound a year from now?Explanation / Answer
Answer:1 The inflation differential is equal to -1% ( =2% - 3%).
Answer:2 qUK/US= (E$/£PUK)/PUS= $120/$100 = 1.2.
Answer:3 The British pound is undervalued by 20% and the U.S. dollar is overvalued by 20% (=1.2 - 1 /1).
Answer:4 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 absolute 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, implying 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. Therefore, after one year, the U.S. real exchange rate,qUK/US,will equal 1.17.
Answer:e From (d), the real exchange rate will decrease by 0.03. Therefore, the rate of real depreciation is equal to - 2.5% ( = -0.03 / 1.20). This implies a real appreciation in the United States relative to the United Kingdom.
Answer:f The expected rate of nominal depreciation can be calculated based on the inflation differential plus the expected real depreciation from (e). In this case, the inflation differential is - 1% and the expected real appreciation is - 2.5%, so the expected nominal depreciation is - 3.5%. That is, we expect a 3.5% appreciation in the U.S. dollar relative to the British pound.
Answer:g The current nominal exchange rate is $2 per pound and we expect a 3.5% appreciation in the dollar (from [f]). Therefore, the expected exchange rate in one year is equal to $1.93 ( =$2 * (1 - 0.035).
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.