Exam 15: Exchange Rates in the Long Run

Suppose that you desperately need a grade of "A" from your International Finance course and further suppose that it depends upon the grade that you will get from the term paper that you write on PPP. Let's assume that you know that your teacher believes that PPP holds anytime anywhere. What kind of evidence would you submit that would indicate that PPP holds? In other words,what kind of countries and data would you choose for your analysis to bias the empirical results regarding PPP?

Endogenous variables tend to be less volatile than exogenous ones.

If American and Japanese consumers buy the same basket of goods in each country and there is no inflation in either country,

We can expect deviations from PPP because of

For which of the following will the law of one price hold best?

Changes in exchange rates are due to

For which of the following is the law of one price least likely to hold?

The establishment of the Euro as a unit of account in 1999 meant that from then on the currencies of the participating countries traded at a fixed rate,until the Euro completely replaced these currencies in the year 2002. (a) How would the inflation rates of these countries have to had been in these transition years for PPP to hold? (b)If the inflation of Italy was twice as high as that of Germany a year between 1999 and 2002,what can we say then about the Italian lira against the German mark? (c)What does the concept of PPP thus tells us about what needs to happen for such this monetary agreement to work for a long period of time?

The higher the inflation differential between countries,the less likely it is that relative PPP will hold.