Question

(a) Whats a simple mathematical expression of the interest rate parity condition and define its components. What is the prediction of this theory in the face of widespread market

expectations for domestic currency depreciation?

Recall: The interest rate parity condition: i = if + x

Where i = domestic nominal interest rate; if = foreign nominal interest rate;

x = expected rate of depreciation of the domestic currency

(b) Does the above theory do a good job at predicting the key facts of the recent Turkish lira story discussed in class?

(c) Given the current circumstances of the Turkish economy, what kind of monetary policy should the country's central bank pursue? Why?

Hint: Monetary policy contraction