1. The Bretton Woods fixed-exchange-rate system was terminated in 1972 and the main currencies of the world now follow a flexible exchange rate system governed by market forces.

a. Graph the Eurozone’s nominal exchange rate and real effective exchange rates from 1994 to present.

What are your observations when comparing the two curves? Would you say that fluctuations in the real exchange rate arise primarily from fluctuations in the nominal exchange rate or from changes in domestic and foreign price levels?

b. The theory says that higher real interest rates, by making the domestic currency’s assets more attractive, ought to strengthen the domestic currency

(all else equal). Graph the interest rate of government securities for the Eurozone and compare it to the first graph on nominal and real effective exchange rates. Do you see the hypothesized relationship between the real interest rate and the exchange rates?