- Price Levels and the Exchange Rate in the ity (PPP), p. 382 hasing power KEY TERMS Fisher effect, p. 39 383 P. 402 real real ex real interest rate, p. 410 change rate, p. 401 relative PPP p. 385 to market, p. 395 OBLEMS 1. Suppose Russia's inflation rate is 50 percent over one year but the inflation rate in the United Kingdom is only 10 percent. According to relative PPP, what should happen over the year to the British pound's exchange rate against the Russian ruble? 2. Discuss why it is often asserted that exporters suffer when their home currencies appreciate in real terms against foreign currencies and prosper when their home cur- rencies depreciate in real terms. 3. Other things equal, how real exchange rate against foreign currencies? . The overall level of spending doesn't change, but domestic residents decide to spend more of their income on nontraded products and less on tradables. b. Foreign residents shift their demand away from their own goods and home country's exports 4. Large-scale wars typically bring a suspension of international trading and financial activities. Exchange rates lose much of their relevance under these conditions, but once the war is over governments wishing to fix exchange rates face the problem of deciding what the new rates should be. The PPP theory has often been applied to this problem of postwar exchange rate realignment. Imagine that you are the French Finance Minister and World War I has just ended. Explain how you would figure out the dollar/franc exchange rate implied by PPP. When might it be a bad idea to use the PPP theory in this way? would you expect the following shifts to affect a currency's 5. In the late 1970s, Britain seemed to have struck it rich. Having developed its North Sea oil-producing fields in earlier years, Britain suddenly found its real income higher as a result of a dramatic increase in world oil prices in 1979-1980. In the early 1980s, how- ever, oil prices receded as the world economy slid into a deep recession and world oil demand faltered. In the following chart, we show index numbers for the average real exchange rate of the pound against several foreign currencies. (Such average index numbers are calle ealefective exchange rates.) A rise in one of these numbers indicates a real appreciatio f the pound, that is, an increase in Britain's price level relative to the average pri vel abroad measured in pounds. A fall is a real depreciation. - Price Levels and the Exchange Rate in the ity (PPP), p. 382 hasing power KEY TERMS Fisher effect, p. 39 383 P. 402 real real ex real interest rate, p. 410 change rate, p. 401 relative PPP p. 385 to market, p. 395 OBLEMS 1. Suppose Russia's inflation rate is 50 percent over one year but the inflation rate in the United Kingdom is only 10 percent. According to relative PPP, what should happen over the year to the British pound's exchange rate against the Russian ruble? 2. Discuss why it is often asserted that exporters suffer when their home currencies appreciate in real terms against foreign currencies and prosper when their home cur- rencies depreciate in real terms. 3. Other things equal, how real exchange rate against foreign currencies? . The overall level of spending doesn't change, but domestic residents decide to spend more of their income on nontraded products and less on tradables. b. Foreign residents shift their demand away from their own goods and home country's exports 4. Large-scale wars typically bring a suspension of international trading and financial activities. Exchange rates lose much of their relevance under these conditions, but once the war is over governments wishing to fix exchange rates face the problem of deciding what the new rates should be. The PPP theory has often been applied to this problem of postwar exchange rate realignment. Imagine that you are the French Finance Minister and World War I has just ended. Explain how you would figure out the dollar/franc exchange rate implied by PPP. When might it be a bad idea to use the PPP theory in this way? would you expect the following shifts to affect a currency's 5. In the late 1970s, Britain seemed to have struck it rich. Having developed its North Sea oil-producing fields in earlier years, Britain suddenly found its real income higher as a result of a dramatic increase in world oil prices in 1979-1980. In the early 1980s, how- ever, oil prices receded as the world economy slid into a deep recession and world oil demand faltered. In the following chart, we show index numbers for the average real exchange rate of the pound against several foreign currencies. (Such average index numbers are calle ealefective exchange rates.) A rise in one of these numbers indicates a real appreciatio f the pound, that is, an increase in Britain's price level relative to the average pri vel abroad measured in pounds. A fall is a real depreciation