Question: The real exchange rate (RE) is defined as the nominal exchange rate (NE) times the ratio of the domestic price to foreign price. Thus, RE

The real (RE) is defined as the nominal (NE) times the ratio of the domestic price to foreign price. Thus, RE for the United States against UK is
REUS = NEUS (USCPI/UKCPI)
a. From the data given in Table 1-3 of Problem 1.7, compute REUS.
b. Using a regression package you are familiar with, estimate the following regression:
NEUS = B1 + B2REUS + u (1)
c. A priori, what do you expect the relationship between the nominal and real exchange rates to be? You may want to read up on the purchasing power parity (PPP) theory from any text on international trade or macroeconomics.
d. Are the a priori expectations supported by your regression results? If not, what might be the reason?
*e. Run regression (1) in the following alternative form:
In NEUS = A1 + A2In REUS + u (2)
where In stands for the natural logarithm, that is, log to the base e. Interpret the results of this regression. Are the results from regressions (1) and (2) qualitatively the same?

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