Question

If the General Price level (p) in the U.S was 100 in comparison to 85 (P) in Canada on June 30, 2015, what would be the real CAN/US exchange rate? IF inflation takes place in Canada, causing its general price level to rise to 120, what happens to the nominal and real CAN/US exchange rates? If a Canadian tourist travels to the United States on that day, which would offer the traveler greater buying power? Use table 2.4 for nominal exchange rates.( 1.235 CAN/ USD on June 30 2015 from the table}

Answer 1

1. Real exchane rate = Spot rate (CAN/US) * [CPI(US)/CPI(CAN)]
   • real exchange rate = 1.235 * [100/80]
   • real exchange rate = 1.45294
2. Nominal and real exchange rate in CAN
   • Inflation in CAN = 120
   • Real exchange rate = 1.02917 {i.e; 1.235 * [100/120]}
   • As per international Fisher relation, Nominal rate = real rate + expected inflation. So inflation rise in CAN affects negatively on CAN dollar and thus US dollar is appreciated, making real and nominal exchange rates increase.
3. If Canadian tourist travels to the USA when CAN$ depreciated, then buying CAN$ (or selling US$) has greater buying power.