Question

Here are 3 monetary policy rules. Assume that PPP, Quantity Theory, and the Fisher effect are correct.

a. The Swiss National Bank (central bank) targets money supply growth and sets it at 8% per year. The growth rate of real Swiss GDP is 3%. What is Switzerland’s inflation rate? What money supply growth rate would result in 2% inflation?

b. The Reserve Bank of New Zealand targets the nominal interest rate. Its target is 6%. The real interest rate is 1.5%. What is New Zealand’s inflation rate? What nominal interest rate target would result in inflation of 2.5%?

c. Lithuania’s central bank targets the exchange rate. It keeps the lita within ± 15% of its target exchange rate of 3.4528 litas per €.

1) What are the upper and lower limits of this exchange rate band?

2) Assume euro inflation is 2% per year and Lithuanian inflation is 5%. By what percent will the lita depreciate against the euro?

3) For how long can the lita stay within the band?

4) Is a fixed exchange rate within a band enough to have Lithuanian inflation converge to Eurozone inflation?

Answer 1