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).
Please answer the following questions. Each question is worth 5 points.
1. What are the assumptions behind the law of one price?
2. What is the meaning of purchasing power parity?
3. 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 the yen against the pound? Does the PPP hold? Explain.
4. Which exchange rate, nominal or real, takes into account price levels in two countries and why?
5. What is the difference between absolute PPP and relative PPP?
6. What is the relationship between money growth, GDP growth, and inflation based on the quantity theory of money (the simple model of monetary approach)?
7. 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 (the simple model)?
The following questions can be submitted next week. We will continue with Chapter 11 in week 4. So, for this writing, the total score is 35.
8. What is the difference between the quantity theory of money and the general theory of money?
9. What is real interest parity?
10. How does a fixed exchange rate act as a nominal anchor to potentially help control a country’s rate of inflation?