Discuss the real exchange rate of finland

Reference no: EM133289252

Assignment:

1. Consider situation in the foreign exchange market on a particular day. The triangular arbitrage condition holds. USD/EUR is 1,09 i.e. by one euro you get 1,09 US dollars. NOK/EUR is 9,90 i.e. by one euro you get 9,90 NOK. What is the value of USD/NOK i.e. how many US dollars will you get by one Norwegian krona?

2. Assume the uncovered interest rate parity holds. In the euro area the one year interest rate is 0% and in Norway 1,5% = 0,015. NOK/EUR rate is 9,90 and thus EUR/NOK rate is 0,1010. What is the expected EUR/NOK rate? Is the euro expected to appreciate or depreciate?

3. Assume the purchasing power parity holds. Inflation in the euro area is 2% and global inflation outside the euro area is 0%. What is the expected appreciation or depreciation of the euro in the foreign exchange market?

4. Consider the real exchange rate of Finland. Inflation in Finland is 2% and global inflation (countries relevant from the point of view of Finland's foreign trade) is 0%. The external value of the euro is exogenous from the point of view of Finland and it appreciates in the foreign exchange market by 5%. How much does the real exchange rate of Finland change? Does it appreciate or depreciate? Is this good or bad for Finnish exports?

5. Let us consider the monetary model of exchange rate determination as explained during the lectures. Assume that the elasticity of money demand with respect to income is 1 and the semi-elasticity with respect to interest rate (bond yield) is 0,5. Consider developments in the euro area and Norway during the forthcoming 5 years. We expect that the ECB boosts monetary expansion by 20% during the 5 year period, cumulative increase in output is expected to be 8% and we expect no change in 5 the year bond yield. Respectively, in Norway monetary expansion is expected to be 10%, cumulative increase in output also 10% and we expect no change in the Norwegian 5 year bond yield. What is the expected inflation in the euro area and in Norway? What is the expected appreciation / depreciation of the euro?

Reference no: EM133289252

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