Grading rubric:
- 0: no submission or finished less than half of the questions with extremely poor answers
- 50: finished at least half of the questions and answers show minimal effort
- 100: finished at least 80% of the questions and answers show satisfactory effort (do not need to be all correct)
Instructions: Please read Chapter 11 Exchange Rates I: The Monetary Approach in the Long Run in your textbook (p. 376 – 381; 388 – 396; 402 – 406; 412). Type up your answers to the following questions:
- What are the assumptions behind the law of one price?
- What is the meaning of purchasing power parity?
- A basket of goods costs £2,000 in the UK and the same basket costs ¥300,000 in Japan. If E¥/£ = 160, what is the real exchange rate of yen against pound? Does the PPP hold? Explain.
- What is the difference between nominal exchange rate and real exchange rate?
- What is the difference between absolute PPP and relative PPP?
- What is the relationship between money supply growth, GDP growth and inflation based on the quantity theory of money?
- If a country increases its money supply growth rate from 2% to 4% per year, all else constant, what will be the impact on its inflation rate and exchange rate according to the monetary approach?
- What is the difference between the quantity theory of money and the general theory of money?
- What is real interest parity?
- How does a fixed exchange rate act as a nominal anchor to potentially help control a country’s rate of inflation?
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