Question

ssume that purchasing power parity holds real exchange rates close to E(f/d) = 1. Suppose:

The nom exchange rate e(EUR/CAD) is decreasing. Where is inflation higher?___________

The nom exchange rate e(GBP/CAD) is increasing. Where is inflation higher?____________

Using the information in a and b, where is inflation highest?

Europe or Canada or Great Britain (circle)

Answer 1

a) e (EUR/CAD) is the nom exchange rate than Europe is the Foreign market and canada is the domestic market. Where when the increase in intrest rates in Canada increases the price level thus reducing the e (EUR/CAD) value. So when price level is higher than the inflation is higher SO Canda has higher inflation.

b) e (GBP/CAD) is the nom exchange rate than Great Britain is the Foreign market and canada is the domestic market. Where when the decrease intrest rates in Canada decreases the price level thus increasing the e(GBP/CAD) value. So when price level is higher than the inflation is higher. SO Great Britain has higher inflation.

C) Great Britain as the highest inflation which means it has high price level than the rest of the two countries.