Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

In the past year inflation has been increasing in many countries. For simplicity, assume that there are only two countries in the World: Australia and

image text in transcribed

In the past year inflation has been increasing in many countries. For simplicity, assume that there are only two countries in the World: Australia and the US. Their central banks adjust monetary policy rates to control inflation. However, inflation has recently grown significantly, from 3.5% to 5.1% in Australia and from 4.7% to 8.5% in the United States. The (nominal) short-term policy rates have been raised recently from 0.10% to 0.85% in Australia and from 0.25% to 0.75% in the USA. Consider the Australian Dollar (AUD) vs. the US Dollar (USD) and assume, for simplicity, that all the the rates in this long question are all annual: 1. What can you tell about the relationship between spot exchange rate and 1 year forward exchange rate based on the information about nominal interest rates alone? Explain your reasoning in words. (5 points) 2. Calculate the (approximate) real interest rate in both countries and the real interest rate differential between Australia and the United States before and after the increase of inflation and interest rates. Compare the two countries and describe the change. (5 points) 3. Suppose that, going forward, the Federal Reserve further increases the policy rate but the RBA does not change its policy rate. How is this likely to affect the exchange rate between the Australian Dollar and the US Dollar (after the further increase of policy rates in the United States)? Explain. (5 points) 4. Explain in your own words the information provided by the Big Mac Index in relation to one of the theories of exchange rate determination studied in the course, as well as the possible limitations of this index. (5 points)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

An Introduction To Socio-Finance

Authors: Jørgen Vitting Andersen, Andrzej Nowak

2013th Edition

3642419437, 978-3642419430

More Books

Students also viewed these Finance questions