Using quarterly data since 2000, graph the EU real exchange rate (as calculated in Exercise 1) and net exports as a fraction of GDP in the same figure. Also create a scatter plot of the same two variables. Is the theoretically predicted relationship of the real exchange rate and net exports visible in the figures?

Data from in exercise 1

Since 1 January 1999 the European Central Bank has been responsible for conducting the monetary policy for the euro area (19 countries and 338 million inhabitants today).

a. Graph the EUR/USD nominal exchange rate from 1999 to the present. Calculate and graph the EU real exchange rate from 1999 to the present, using the CPI of the United States (one of the largest trading partners of the European Union) for the "foreign" price level and the EU CPI (or $HCI$ ) for the domestic price level. Comparing the two graphs, would you say that real exchange-rate fluctuations arise primarily from nominal exchange-rate fluctuations or from changes in domestic and foreign price levels?

b. The theory says that higher EU real interest rates, by making euro assets more attractive, ought to strengthen the euro (all else equal). Add the real interest rate (the fixed rate for main refinancing operations set by the ECB minus inflation rate) to a graph that includes the nominal and real exchange rates. (You may have to rescale some of the variables so that they are on approximately the same scale on the graph.) Do you see the hypothesized relationship between the real interest rate and the exchange rates?