Consider a period when, prior to euro entry, the central bank of Lithuania

maintained an exchange rate band relative to the euroat the time this was a

prerequisite for joining the Eurozone. The rules said that Lithuania had to keep its

exchange rate within

15% of the

central parity of 3.4528 litas per euro. Compute

the exchange rate values corresponding to the upper and lower edges of this band.

Suppose PPP holds. Assuming Eurozone inflation was 2% per year and inflation

in Lithuania was 6%, compute the PPP-implied rate of depreciation of the lita.

Could Lithuania maintain the band requirement? For how long? Does your

answer depend on where in the band the exchange rate currently sits? A primary

objective of the European Central Bank is price stability (low inflation) in the

current and future Eurozone. Is an exchange rate band a necessary or sufficient

condition for the attainment of this objective?