Malawi is a country that has been struggling with high and rising food prices caused by bad weather. Economists at The African Development bank expect inflation to stay at 20% in Malawi over the next three years. On the other side of the world, inflation rates are expected to stay at 1.2% p.a in Australia for each of the next three years. The current spot rate for the Aussie dollar (AUD) against the Malawian Kwacha (MWK) is MWK 538 = AUD 1.

1: If economists are right (and assuming relative PPP holds) then what should the spot value of the MWK be against the AUD in three (3) years time? Give your answer as the number of MWK per AUD to the nearest MWK.

2: Suppose the spot value of the MWK against the AUD turns out in three years time to be 1200 MWK per AUD. What can you say?

a) Over the three years, the AUD has weakened in nominal terms and weakened in real terms. b) Over the three years, the AUD has weakened in nominal terms but strengthened in real terms. c) Over the three years, the AUD has strengthened in nominal terms but weakened in real terms. d) Over the three years, the AUD has strengthened in nominal terms and strengthened in real terms. e) Over the three years, the MWK has strengthened in nominal terms but weakened in real terms. f) Over the three years, the MWK has strengthened in nominal terms and weakened in real terms. g) Answer not above