Assume Purchasing Power Parity (PPP) holds in the long run between the U.S. and Europe. What...

Assume Purchasing Power Parity (PPP) holds in the long run between the U.S. and Europe. What does this already imply for the exchange rate E_($/€)? Write down your answer in the form of an equation and a brief explanation. (2 pts)

Now assume we have PPP and also that the quantity theory of money holds, with the velocity of money V constant and real output Y fixed and constant in both countries. Suppose that the Federal Reserve is expanding the supply of dollars by 5% per year, while the European Central Bank is expanding the supply of euros at 2% a year. What will happen to E_($/€) over time? Give a quantitative answer and a brief explanation. (2 pts)

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Expert Solution

Rahul Sunny answered 2 weeks ago

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