The following are expected interest rates and inflation rates in Canada and Britain over the next six months.
Country
Interest rate
Inflation rate
Canada
9%
4%
Britain
7%
2%
The current exchange rate between the Canadian dollar (C$) and the British pound (£) is
2 C$=1£.
Required:
Determine the six month forward exchange rate between the two currencies using the
following approaches:
(i) Interest rate Parity (IRP) approach.(2 marks)
(ii) Purchasing Power Parity (PPP) approach.(3 marks)
b) By making imports more expensive and exports cheaper, neo-liberal economist (such as McKinnon (1973) and Shaw (1973)) asserts that currency devaluation will reduce trade imbalances, freeing more resources for debt repayment. Do you agree? Explain your answer.
(10 marks)