Question
Consider two countries, A and B. In 1996, Country A experienced slow real output growth (1.0% per year), whereas Country B had robust real output
Consider two countries, A and B. In 1996, Country A experienced slow real output growth (1.0% per year), whereas Country B had robust real output growth (5.0% per year). Suppose the central bank of Country A allowed the money supply to grow by 4.0% each year, whereas the central bank of Country B chose to maintain relatively high money growth of 7.0% per year. Use the general monetary model (where L depends on the interest rate of the country) and the purchasing power parity. Treat Country A as the home country and Country B as the foreign country. In addition, assume that the bank deposits in Country A pay 4% nominal interest per year. What is the depreciation/appreciation rate of the currency of country A against that of country B? Show all working to get full marks.
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