Question: Relative PPP and PPP 1. Large wars often bring about suspended international trade and nancial ows tend to cease. Exchange rates become fairly meaningless in

Relative PPP and PPP Relative PPP and PPP 1. Large wars often bring about suspended international

1. Large wars often bring about suspended international trade and nancial ows tend to cease. Exchange rates become fairly meaningless in these conditions, but after the war is over govern- ments that wish to x the exchange rate face the problem of deciding what the new rates should be. Imagine that you are the British Prime Minister after WWI and you wish to gure out the dollar / pound exchange rate implied by PPP. (a) Would you use absolute or relative PPP? Why? [2 pts] (b) Suppose that US. prices have increased by 10% from before the war until after the war. British prices rose by 20% over the same time period. How should the exchange rate be adjusted given this information? [2 pts] (c) What has your calculation in (b) ignored, which might make you question using the PPP theory that you selected? [2 pts]

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