Question

In the long run exchange rate model based on PPP, what happens to the exchange rate when 1)Money supply increases permanently, A rise in interest rate and A rise in output level Thanks.

Answer 1

Purchasing power parity measures the price of different countries to compare the absolute purchasing power of the currency. The PPP didn’t consider the poverty, tariff and other fictions.
A.Money supply increased permanently; the rise in money supply will leads to the long run depreciation of the currency. This long run money supply will alter the expectation. With depend to the PPP; the depreciation of the currency will lower the interest rate. This will lead to liquidity trap. This will reduce the exchange rate. Thus the export will be cheaper and the import becomes expensive. This will boost export. There is development of the domestic firms.
B.A rise in interest rate; the rise in interest rate will increase the exchange rate. This will attract more foreign capital to the domestic country. This will raise the currency vale, appreciation. This appreciation leads to cheaper import and expensive export. Thus the dependence of foreign country will increase through high rate of import. This will negatively affect the domestic country.
C.Rise in output level; the domestic price level is foreign price level multiplied y the exchange rate. The exchange rate will rise with respect to the rise in output. While considering the PPP, the purchasing power of one country with rise in output will leads to the appreciation of the currency. This appreciation leads to the increasing level of foreign relation. This increase the export level also.