Exercise 6 e EUR is the inflation expected in the Eurozone between period t and period t

Exercise 6

πe EUR is the inflation expected in the Eurozone between period t and period t 1 1, and πe UK the inflation expected in the United Kingdom during the same period. St is the nominal exchange rate of the euro with respect to the pound (h/d) for period t and E(St11) is the nominal exchange rate expected for the next period. Assuming that the purchase power parity is valid, answer the following items.

a. If πe EUR rises in relation to πe UK, what should occur with the expected depreciation of the euro?

b. What is the impact on the real interest rate differential, iEUR 2 iUK?

c. How would your answer change for the previous item if the purchasing power parity was not valid?