Assume: The current dollar-euro exchange rate E is $1.32 per euro. A U.S. basket that costs...

 

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Assume: The current dollar-euro exchange rate E is $1.32 per euro. A U.S. basket that costs $120 would cost €100 in the Eurozone. For the next year, U.S. inflation is expected to be 6% and Eurozone inflation is expected to be 1%. a. What is expected U.S. minus Eurozone inflation (TuS - TEUR) in the next year? [1] b. What is the current U.S. real exchange rate (q) with the Eurozone? (price of Eurozone basket relative to U.S. basket) [1] c. Based on PPP, by how much (in % terms) is the dollar undervalued versus the euro (i.e., by what percentage is a bigger than 1)? [2] d. Assume that 20% (or 1/5) of the deviation from PPP (i.e., 20% of the difference between q and 1) is eliminated each year through gradual adjustment (arbitrage). If so, what would be the expected level of q one year from now? [2] e. Based on the last answer, how much (in %) will the dollar be undervalued versus the euro next year, assuming nothing else happens? And what is the expected rate of change in q (i.e., what is Aq/q) from this year to next year? [2] f. Given the expected rate of change in q (in part e), and the expected inflation differential (in part a), what is the expected rate of nominal depreciation AE/E for the delar (versus the euro) for the coming year? [2] Assume: The current dollar-euro exchange rate E is $1.32 per euro. A U.S. basket that costs $120 would cost €100 in the Eurozone. For the next year, U.S. inflation is expected to be 6% and Eurozone inflation is expected to be 1%. a. What is expected U.S. minus Eurozone inflation (TuS - TEUR) in the next year? [1] b. What is the current U.S. real exchange rate (q) with the Eurozone? (price of Eurozone basket relative to U.S. basket) [1] c. Based on PPP, by how much (in % terms) is the dollar undervalued versus the euro (i.e., by what percentage is a bigger than 1)? [2] d. Assume that 20% (or 1/5) of the deviation from PPP (i.e., 20% of the difference between q and 1) is eliminated each year through gradual adjustment (arbitrage). If so, what would be the expected level of q one year from now? [2] e. Based on the last answer, how much (in %) will the dollar be undervalued versus the euro next year, assuming nothing else happens? And what is the expected rate of change in q (i.e., what is Aq/q) from this year to next year? [2] f. Given the expected rate of change in q (in part e), and the expected inflation differential (in part a), what is the expected rate of nominal depreciation AE/E for the delar (versus the euro) for the coming year? [2]

Answer rating: 100% (QA)

a ANSWER USTEUR inflation is expected to be 5 in the next year WORKING Et1 Et 1i 132 1001 133 So USTEUR inflation is 5 EXPLANATION In order for the do... View the full answer