L9

Question 1

PPP tries to explain

Answer 1

how inflation effects exch

Question 2

PPP model

Answer 2

Relies on law of one price- assest should sell at same price after taking exch into consid

Question 3

PPP hold

Answer 3

Doesnt in ST- large persistent deviations
holds in LT

Question 4

Inflation in PPP

Answer 4

= (P1-Po)/Po

Question 5

PPP- internal and external PP

Answer 5

should equal each other

1/Poa = 1/SoPPP X 1/Pob
or
SoPPP= Poa/Pob

Question 6

Internal PP

Answer 6

1/Poa= 1/Price level country A current period

Question 7

External PP in Currency A

Answer 7

1/ SoPPP X 1/Pob = 1/current spot exch predicted by PPP x 1/ Price level country B

Question 8

What if SoPPP doesnt equal Poa/ Pob

Answer 8

Abtrirage opp

Question 9

PPP curr predictions

Answer 9

Overvalued- should deprecate
Undervalued- Should aprreciate

variations due to
* tariffs and quotas
* Trans cost
* Non competitive Market

Question 10

Overvaluation of Curr1 means undervaluation of Curr2

Answer 10

Means External PP of Cur1 > Internal PP
Curr2 Internal PP> External PP

Question 11

Why Absolute PPP doesnt hold

Answer 11

Changes in relative Prices
No substitutes for traded foods
Non traded goods- Housing
changes in BOP

Question 12

Relative PPP

Answer 12

used as market is imperfect, prcies of same baskest of products in diff countries wont be the same
the rate should be similar- % change in exch should be roughly equal to the diff in inflat between 2 countries

Question 13

% change PPP exchange

Answer 13

ePPP= (S1PPP-SoPPP)/SoPPP

Question 14

Inflation 2 countries

Answer 14

A= (P1/Po) -1
B is the same
Hence 1+ePPP = (1+InflatA)/(1+Inflat B)
ePPP roughly equals The diff in inflation rates

Question 15

RPPP

Answer 15

Tries to predicted the % change in exch from the diff of Inflation as:
* Inflation lowers PP of money= inflat diff across countries should change nominal exchange rate to compensate

Question 16

Sum of PPP

Answer 16

Higher Inflation= Higher imports, lower exports= Local curr deprecation
vice versa

Question 17

IFE- international Fisher Effect

Answer 17

Diff in nominal I between countries can be used to predict changes in exch
Hence: -Fisher effect
When Inflat ^, central banks should rise I

Question 18

Real Return

Answer 18

R= Inflation - I
This can be expressed in terms of PP

Question 19

If IFE holds

Answer 19

E(ePPP)= ( Id- If)
countries with high inflation should have high nominal I

Question 20

IFE empirical evidence

Answer 20

doesnt support in ST
LT suggests validity

Question 21

Implication of IFE

Answer 21

Cur with High I will have high Inflat. The high Inflat will cause a deprec cause of the PPP effect
Hence
* foreign investors are adversely effected by high inflat if they try to cap on high I

Question 22

Limitations of IFE

Answer 22

relies on fisher and PPP effect
*Fisher Limit- diff between nominal I and actual Inflat is not consistnet
*PPP limit- other country features besides Inflat can effect Exch movement

Question 23

Fisher effect

Answer 23

Nominal I should reflect Inflat expectations

Question 24

Diff between IRP PPP IFE- IRP

Answer 24

IRP- focus on why FWD differes from spotand on degree of diff that should exist. relates to specific point in time

Question 25

Diff between IRP PPP IFE- PPP

Answer 25

PPP and IFE focus on how cur spot will change overtime
PPP suggests that spot will change in accord with Inflat

Question 26

Diff between IRP PPP IFE- IFE

Answer 26

PPP and IFE focus on how cur spot will change overtime
IFE suggests that it will change in accord with I diff

Question 27

how are PPP and IFE related

Answer 27

Becauswe expected Inflat diff influences Nominal I between 2 Countries