(1) Derive the Lira-German mark exchange rate as a cross rate using the Lira-U.S. dollar and mark-U.S. dollar exchange rates. (2) Assume that the Italian Lira was at its purchasing power parity value and hence in equilibrium relative to both the US dollar and the German mark in 1973. Compute PPP values of the Lira against both currencies for the remaining years of the sample.

The file PPP_Calculations.xls provides a detailed example of how to make these computations. Three steps are involved. The first is to rebase the CPIs to 1973 by dividing all of the yearly observations by the relevant 1973 figure and multiplying those figures by 100. The second is to divide the rebased CPI series for Italy by the relevant foreign CPI series. That gives you indices of relative price levels with a 1973 base value of 1. The third step is multiply these indices by the value of the relevant exchange rate in 1973. That gives you series of PPP values, i.e. what the actual exchange rate would be in each year if PPP held fully.

(3) In Fall 1992, the value of the Liras declined precipitously against the mark and even more so the dollar. From August 1992 to the February 1993 the declines were 22% and 34% respectively. Based on your calculations in (2) were these declines moves towards or away from equilibrium? Explain.

(4) From 1999 on, the Lira has been part of the Euro bloc. It is, however, possible to compute synthetic Lira/$ and DM/$ rates using Euro/$ rates and the conversion rates for the Euro countries currencies. I have done this. The resultant figures are shown in the table for the years 1999-2003. Comment on their relation relative to PPP over this period.

Period	Exch. Rate	US CPI	UK CPI	US CPI	UK CPI	Relative CPI	PPP
	USD/GBP	2000=100	2000=100	2003=100	2003=100	2003=1	USD/GBP
1990	1.78	75.88	74.08	71.03	69.56	1.02	1.67
1991	1.77	79.09	78.42	74.03	73.63	1.01	1.64
1992	1.77	81.48	81.35	76.28	76.38	1.00	1.63
1993	1.50	83.89	82.62	78.53	77.58	1.01	1.65
1994	1.53	86.08	84.66	80.58	79.50	1.01	1.66
1995	1.58	88.49	87.55	82.84	82.21	1.01	1.65
1996	1.56	91.09	89.70	85.26	84.22	1.01	1.65
1997	1.64	93.22	92.51	87.26	86.86	1.00	1.64
1998	1.66	94.66	95.67	88.61	89.83	0.99	1.61
1999	1.62	96.73	97.16	90.55	91.23	0.99	1.62
2000	1.52	100.00	100.00	93.61	93.90	1.00	1.63
2001	1.44	102.83	101.82	96.25	95.61	1.01	1.65
2002	1.50	104.46	103.49	97.78	97.17	1.01	1.64
2003	1.63	106.83	106.50	100.00	100.00	1.00	1.63
2004	1.83	109.69	109.66	102.68	102.96	1.00	1.63
2005	1.82	113.41	112.76	106.16	105.88	1.00	1.64
2006	1.84	117.07	116.36	109.59	109.26	1.00	1.64
2007	2.00	120.41	121.34	112.71	113.93	0.99	1.62
2008	1.85	125.03	126.18	117.04	118.48	0.99	1.61
2009	1.64	124.51	125.36	116.55	117.71	0.99	1.62