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b. Suppose that U.S. inflation over the next five years turns out to average 3.2%, German inflation averages 1.5%, and the exchange rate in five
b. Suppose that U.S. inflation over the next five years turns out to average 3.2%, German inflation averages 1.5%, and the exchange rate in five years is $0.99/E. What has happened to the real value of the euro over this five-year period? ANSWER. According to Equation 4.7, the real value of the euro at the end of five years is (1 + if ) 0.99x( 1.015 et = et 5 =0.9111 (1 + in) 1.032 Hence, even though the euro has appreciated in nominal terms over this five-year period, it has fallen in real terms by 4.09% [(0.9111 - 0.95)/0.95]
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