4) Given inflation rates of 1% and 3% in Japan and US respectively, what is the...

4) Given inflation rates of 1% and 3% in Japan and US respectively,

what is the prediction according to RPPP with regards to the yen /$

exchange rate?

5) The Yen /USD spot exchange rate is 100. The current interest rate is

3% in the U.S. and 1% in Japan.

a) Explain the International Fisher Effect (IFE)?

b) What will be the exchange value change of the Japan Yen under

IFE?

Solutions

Expert Solution

Answer to Question No 4
Inflation rate in Japan	1%
Inflation rate in US	3%
1. Since the US Inflation rate is higher than the Japan Inflation rate the Purchasing power of USD
shall decrease more as comparing to Japanese Yen.
2. Hence the Yen/USD exchange rate shall decrease to knock off any arbitrage gain

Answer to Question No 5
a. The theory of "International Fisher Effect" state that changes in anticipated Inflation produce
corresponding changes in the rate of interest. And interest rate differences between nations
provide an unbiased predictor of future changes in spot exchange rates

b. Spot Exchange rate	100	Yen/USD
Interest rate in US	3%
Interest rate in Japan	1%
Under IFE exchange rate would be		= 100*(1.01/1.03) =	98.05825	Yen/USD

jeff jeffy answered 11 months ago

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