Suppose we consider two countries, a home country and a foreign country. In the home country, the expected inflation rate is equal to 3.6 per cent, while the expected inflation rate abroad is equal to 4.2 per cent. Furthermore, it is known that the nominal interest rate in the home country is equal to 3.4 per cent, while the nominal interest rate abroad is equal to 4 per cent. a) First explain what is meant by absolute purchasing power parity, relative purchasing power parity and uncovered nominal interest rate parity. Then give an estimate of the expected growth in the nominal exchange rate based on each of the three theories. Finally, show that if both relative purchasing power parity and uncovered nominal interest rate parity apply, real interest rates in the two countries will be approximately equa
Suppose we consider two countries, a home country and a foreign country. In the home country, the expected
inflation rate is equal to 3.6 per cent, while the expected inflation rate abroad is equal to 4.2 per cent. Furthermore, it
is known that the nominal interest rate in the home country is equal to 3.4 per cent, while the nominal interest rate
abroad is equal to 4 per cent.
a) First explain what is meant by absolute
uncovered nominal interest rate parity. Then give an estimate of the expected growth in the nominal
exchange rate based on each of the three theories. Finally, show that if both relative purchasing power parity
and uncovered nominal interest rate parity apply, real interest rates in the two countries will be
approximately equal.
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