USE THIS INFORMATION TO ANSWER QUESTION 1: In US the Federal Interest rate in 20
ID: 3221351 • Letter: U
Question
USE THIS INFORMATION TO ANSWER QUESTION 1:
In US the Federal Interest rate in 2014 and 2015 was averaged at 5.81%. In March 2017, it came down to 1%.
In Poland, the Interest Rate in March 2014 was 7.28% and in 2015 the Interest Rate came down to 1.5%.
There is similarity in decline in interest rate due to recession that started in 2008.
In US Inflation Rate in February 2014 was 2.6% and in Feb. 2015 the Interest rate was 2.7%.
In Poland the Inflation rate in 2014 was 0.05 %, and in 2015 was -0.87 %.
In US the money demand was stable as interest rate was stable; but in Poland the demand for money might be very high as the interest rate was below zero i.e. -0.87
Fisher Effect
Let us check the Fisher Effect in the US and Poland
Formula of Fisher effect:
(1+nominal rate) = (1+real rate)x(1+inflation rate)
US for 2014
(1+5.81/100) =(1+5.2/100)x(1+2.6/100)
=>1.0581 =(1.052)x(1.026)
=>1.0581 =1.0856 a good approximation
For 2015
(1+5.81/100)=(1+2.24/100)x(1+2.7/100)
=>1.0581 =1.0224x1.027
=>1.0581 = 1.05 Perfect Approximation
Question 1:
Relative PPP. Use information in 1.1 and he information from Part I question 1.2 to test relative purchase power parity. Does it hold for year 2014 and year 2015?
Note: Relative PPP states that the rate of change in the exchange rate is equal to differences in the rates of inflation.
Explanation / Answer
Relative PPP states that the rate of change in the exchange rate is equal to differences in the rates of inflation
First find the exchange rate
For 2014
exchange rate = 2.6-0.05 = 2.55
For 2015
exchange rate = 2.7-(-0.87) = 3.57
For 2014, test relative purchase power parity is
(1+nominal rate) = (1+real rate)x(1+inflation rate)
US for 2014
(1+5.81/100) =(1+(5.81-2.55)/100)x(1+2.6/100)
=>1.0581 =(1.0326)x(1.026)
=>1.0581 =1.059 a perfect approximation
For 2015
(1+5.81/100)=(1+2.24/100)x(1+2.7/100)
=>1.0581 =1.0224x1.027
=>1.0581 = 1.05 Perfect Approximation
Poland for 2014
(1+7.28/100) =(1+(7.28-2.55)/100)x(1+0.05/100)
=>1.0728 =(1.0473)x(1.005)
=>1.0728 =1.0525 a good approximation
For 2015
(1+6.13/100) =(1+(6.13-3.57)/100)x(1-0.87/100)
=>1.0613 =1.0256x1.005
=>1.0613 = 0.9363 not good Approximation
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