Question

Suppose that one year US and Polish rates are 2.5% and 6.5% respectively. One year US inflation forecast is 1.5%. What should be the expected inflation rate in the Poland if we can assume that International Fisher Effect holds? [Hint: Use accurate Fisher Effect formula on slide #5 in Parity Relationships-2 ; do not use approximation]

a. 0.90%

b. 5.46%

c. 1.50%

d. 6.50%

Answer 1

Using Fisher equation formula
(1+nominal interest rate)=	(1+ Real Interest rate)	(1+Inflation rate)
In US
Nominal Interest Rate=	2.50%
Inflation Rate=	1.50%
Using Fisher equation formula
(1+ 0.025)=	(1+ Real Interest rate)	(1+0.015)
(1+ 0.025)/(1+0.015)=	(1+ Real Interest rate)
1.0099=	(1+ Real Interest rate)
Real Interest rate=	1.0099-1
Real Interest rate=	0.0099
Real Interest rate=	0.99%
In Poland
Nominal Interest Rate=	6.50%
Real Interest rate=	0.99%
Using Fisher equation formula
(1+nominal interest rate)=	(1+ Real Interest rate)	(1+Inflation rate)
(1+0.065)=	(1+ 0.0099)	(1+Inflation rate)
(1+0.065)/(1+0.0099)=	(1+Inflation rate)
(1+Inflation rate)=	1.05455
Inflation rate=	1.05455-1
Inflation rate=	0.05455
Inflation rate=	5.46%
Expected Inflation Rate in the Poland= 5.46%