2. The U.S. foreign assets are 67 percent of the U.S. GDP, and the U.S. foreign

Question

2. The U.S. foreign assets are 67 percent of the U.S. GDP, and the U.S. foreign liabilities are 90 percent of the U.S. GDP. Moreover, 68 percent of U.S. foreign assets are denominated in foreign currencies, while almost all liabilities to foreigners are denominated in U.S. dollars. In this question, assume that all U.S. liability to foreigners are denominated in U.S. dollars. Suppose that there is a 9 percent appreciation of the dollar. Will the U.S. net foreign asset position increase or decrease? By how much (as a percent of U.S. GDP)? Show your work.

3. In 2017, prices increase by 1.54% in Europe (in euros) and 2.1% in the US (in dollars). According to PPP, the euro should appreciate or depreciate? By how much?

Explanation / Answer

Suppose US GDP = $100.

US Foreign Asset will be $67.

US Foreign Liability will be $90..

Foreign asset denominated in foreign currency = $67*68% = $45.56.

Liability in foreign currency is almost 0.

Which means we are having only $45.56 assets denominated in foreign currency.

If there is a 9% appreciation in foreign currency, our foreign asset wil appreciate by 45.56*9% = $4.

So, as a percenage of GDP, our net foreign asset will appreciate by 4/100 = 4%

3) Purchasing power parity (PPP) states that the exchange rate between two countries is equal to the ratio of the currencies respective purchasing power.

That means if the price of product in a country rises, their purchasing power will decrease and hence their competitive exchange rates will fall down.

Here, we see that price increase in Europe is 1.54% whereas price increase in US is 2.1% that means US currency will depreciate more than europe or we can say Europe will appreciate as compared to US.

The appreciation will be close to 2.1%/1.54% = 1.36%

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