Question
SupposethatthecentralbankintheUK(TheBankofEngland)decidestoraiseinterestratesbecauseitisworriedabouthighinflation.Asaresult,interestratesintheUKbecomehigherthaninterestratesintheRESTOFEUROPE.ThisactsasanincentiveforEUROPEANinvestorstoincreasetheamountoffundstheyinvestinBritish(UK)interestbearingassets.InordertoincreasetheirpurchasesofthoseUKassets,whicharepricedinPST,EUROPEANinvestorshavetoconvertEURintoPST.Thisconversion,inturn,increasesthedemandforPST.Basedontheaboveinformation,pleaseexplain:i) (1pt)GiventhatinterestratesintheUKarenowdifferentthanthatinEurope,whatmodel/equation/conditionmaybeusedtoexplainthisbehaviorofthe(nominal)exchangerate.(Note:youjustneedtostatethenameofthemodelorequationorconditionthatmaybeused).ii) (1pt)whatwillhappentotheEURPSTexchangerate.Inotherwords,willtheincreaseddemandforPST,makePSTgainvalue(appreciate)orlosevalue(depreciate)againsttheEUR?(Pleaseindicateyouranswerbypickingoneofthefollowing:Appreciate/Depreciate/Staythesame.iii) (2pts)Why?Pleasegiveabriefexplanationusingwhatyouchoseinpartc(i).
SupposethatthecentralbankintheUK(TheBankofEngland)decidestoraiseinterestratesbecauseitisworriedabouthighinflation.Asaresult,interestratesintheUKbecomehigherthaninterestratesintheRESTOFEUROPE.ThisactsasanincentiveforEUROPEANinvestorstoincreasetheamountoffundstheyinvestinBritish(UK)interestbearingassets.InordertoincreasetheirpurchasesofthoseUKassets,whicharepricedinPST,EUROPEANinvestorshavetoconvertEURintoPST.Thisconversion,inturn,increasesthedemandforPST.Basedontheaboveinformation,pleaseexplain:i) (1pt)GiventhatinterestratesintheUKarenowdifferentthanthatinEurope,whatmodel/equation/conditionmaybeusedtoexplainthisbehaviorofthe(nominal)exchangerate.(Note:youjustneedtostatethenameofthemodelorequationorconditionthatmaybeused).ii) (1pt)whatwillhappentotheEURPSTexchangerate.Inotherwords,willtheincreaseddemandforPST,makePSTgainvalue(appreciate)orlosevalue(depreciate)againsttheEUR?(Pleaseindicateyouranswerbypickingoneofthefollowing:Appreciate/Depreciate/Staythesame.iii) (2pts)Why?Pleasegiveabriefexplanationusingwhatyouchoseinpartc(i).
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