1.7 The UK pound is trading at 1.54 US dollars per UK pound. There is purchasing power parity at this exchange rate. The interest rate in the US is 2 per cent a year and the interest rate in the UK is 4 per cent a year.

a Calculate the UK interest rate differential.
b What is the UK pound expected to be worth in terms of US dollars one year from now?
c Which country, more likely, has the lower inflation rate? How can you tell?