Look back at equation (20.3) in Section 20.2.
(a) Apply our growth rates rules (from Chapter 3) to this equation to express the growth rate of the exchange rate as a function of the inflation rate at home and abroad.
(b) Between 1975 and 1995, U.S. inflation averaged 5.7% per year, while inflation in Japan averaged 3.6% per year. At what rate should we expect the dollar to depreciate against the yen between 1975 and 1995?
(c) Using Figure 20.1, make a rough calculation of the annual rate of depreciation of the dollar versus the yen. Do the numbers match up reasonably well?

(d) What must have been happening to the real exchange rate between 1975 and 1995? Can you think of any reason why this might have occurred?

FIGURE 20.1 The U.S. Exchange Rate versus the Yen and the Euro 400 Yen per dollar (left scale) Euros per doilar right scale) 1.25 300 200 100 .75 1970 1975 190 1985 95 2000 2005 2010 2015 Year