Question

In: Economics

A country has a lower inflation rate than all other countries. It has more rapid economic...

  • A country has a lower inflation rate than all other countries. It has more rapid economic growth. The central bank does not intervene in the foreign exchange market. What can you say (and why) about:
  • The exchange rate?
  • The current account balance?
  • The expected exchange rate?
  • The interest rate differential?
  • Interest rate parity?
  • Purchasing power parity?

Solutions

Expert Solution

A country has a lower inflation rate than all other countries. It has more rapid economic growth. The central bank does not intervene in the foreign exchange market. What can you say (and why) about:

Theory: When a country has less inflation rate then it means that it can produce more competitively within the country and it will have more competitive products in world market due to low costs of production. It will create more markets for its exports and as exports increase, the demand for home currency will increase and this leads to appreciation of home currency. More exports will also lead to balance of trade being more on a positive side. As the demand for money goes up in home country the interest rates are likely to go up.

The exchange rate?- As discussed earlier- It appreciates.

The current account balance? it improves as more exports are being made possible.

The expected exchange rate? The domestic currency rate will go up as people expect to go up further.

The interest rate differential(IRD)? It measure the difference in interest rates between two securities.: Hence the IRD would go up.

Interest rate parity? Home currency will be exchanges for more expensive future prices than the current spot prices.

Purchasing power parity? As home currency is getting expensive purchasing power parity will go down as

Rahul Sunny answered 1 year ago
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