1. Figure 2 shows the nominal EUR/USD exchange rate for the period 2000-2022. Shaded areas represent periods of US recession. Based on the information given in the graph, answer the following questions: (a) (4 points) In September 2008, the Great Financial Crisis erupted with the collapse of Lehman Brothers. i. Can you find what happened to the euro in terms of depreciation/appreciation relative to the dollar? ii. What was the trend in the previous two years? (b) (6 points) In January 2018, the value of the exchange rate was 0.81993 EUR/USD. Suppose that the price of pecorino cheese in Italy was 24 euros per kilo at that date and that it didn't change from January 2018 until January 2020. i. Using the information in the graph, compute the USD value of Italian pecorino cheese at both dates. Did Italian pecorino cheese become less or more expensive in terms of US dollars? ii. If instead you know that the overall change in price in Italy from January 2018 to January 2020 was 15%, how would your answers change? (c) (6 points) Suppose that in January 2020 the price of the same pecorino cheese in the US was 35 USD per kilo. Considering the price of Italian pecorino cheese in 2020 you calculated to include the 15% overall inflation, would you say that the law of one price held at that date? (ignore transportation costs or any other trade barriers) Explain how a possible mismatch in prices of the Italian pecorino cheese in the two countries at the given exchange rate in 2020 could be exploited up until the law of one price held. 3 (d) (3 points) From January 2018 to January 2020, what overall inflation in the US would have matched the Relative Purchasing Power Parity condition? (e) (6 points) The exchange rate in January 2019 was 0.87573 EUR/USD. In January 2019, suppose that a deposit in US dollars gave a nominal annual return of 5% , while a deposit in Euros gave a nominal annual return of 6%. If a European investor saw in a crystal ball the actual nominal exchange rate for January 2020, would she have preferred to invest in dollar deposits or euro deposits as of January 2019? Explain.FRED - National Currency to US Dollar Exchange Rate: Average of Daily Rates for the Euro Area 1.2 1.1 1.0 Jan 2020: 0.90073 National Currency Units per US Dollar 0.9 ww 0.8 0.7 0.6 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Figure 2: Exchange rate: EUR per 1 USD