Download 10 THE EXCHANGE RATE AND THE BALANCE OF PAYMENTS**

C h a p t e r
10
THE EXCHANGE
RATE AND THE
BALANCE OF
PAYMENTS**
Solutions to the Odd-Numbered Problems
1.
a.
b.
c.
d.
e.
f.
3.
The real exchange rate equals E × (P/P*) where E is the nominal exchange rate, P is the U.S.
price level and P* is the Japanese price level. Rearranging this equation gives that the nominal
exchange rate equals RER × (P*/P) where RER is the real exchange rate. Thus the nominal
exchange rate equaled 103.6 × (95.4/106.3), or 93.0 yen per dollar.
5.
For interest rate parity to hold, the Japanese yen must be expected to appreciate by the difference
in the interest rates. So the Japanese yen must be expected to appreciate by 2.8 percent minus
0.036 percent, or 2.764 percent.
7.
The price of the laptop converted to U.S. dollars equals 12,960 Mexican pesos ÷ 10.8 Mexican
pesos per dollar, or $1,200.
9.
a.
b.
c.
d.
11. a.
b.
*
The U.S. dollar depreciated against the Canadian dollar.
The U.S. dollar appreciated against the Japanese yen.
One Canadian dollar was worth 77 U.S. cents in 2004 and 83 U.S. cents in 2005.
One hundred Japanese yen were worth 92 U.S. cents in 2004 and 91 U.S. cents in 2005.
The Canadian dollar appreciated against the U.S. dollar.
The Japanese yen depreciated against the U.S. dollar.
The private sector balance equals saving (£162 billion) minus investment (£181 billion), or
−£19 billion.
The government sector balance is equal to net taxes (£217 billion) minus government
expenditures on goods and services (£230 billion), or −£13 billion.
Net exports equals the private sector balance (−£19 billion) plus the government sector
balance (−£13 billion), or −£32 billion. The U.K. had a net export deficit of £32 billion.
The government sector balance plus the private sector balance equals net exports. If the
government sector balance changes and the private sector balance does not change, then net
exports change by the same amount as the change in the government sector balance.
The exchange rate most likely rises—the currency appreciates. The reason is that to preserve
purchasing power parity, with a lower inflation rate, the currency must appreciate.
The current account balance depends on domestic investment relative to national saving. The
balance could be positive or negative. Possibly with more rapid growth, investment in the
country is high and so the current account might be in deficit.
* This is Chapter 26 in Economics.
1
c.
d.
e.
f.
2
The exchange rate will be expected to appreciate so the expected future exchange rate is
higher than the current exchange rate.
The interest rate differential is negative. The interest rates in some other country exceeds the
domestic interest rate by a amount equal to the expected exchange rate appreciation.
Interest rate parity holds every day. If it did not, profits would be available. Such profit
opportunities do not go unexploited.
Purchasing power parity probably doesn’t hold every day, but does hold on the average in
the long run.