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Q. Imagine that the economy is at a point on the DD-AA schedule that is above both AA and DD and where both the output and asset markets are out of equilibrium. Explain what will happen next.
Answer: Since the asset market adjusts extremely quickly the exchange rate drops immediately to a point on the AA schedule and there will be excess demand for the domestic currency because the high expected future appreciation rate of the domestic currency implies that the expected domestic currency return on foreign deposits is below that on domestic deposits. This surplus demand escorts to an immediate fall in the exchange rate.
Discuss the effects of ongoing inflation based on the PPP theory. Answer: Other things equivalent money supply growth at a constant rate eventually results in ongoing price le
Q. Explain Purchasing Power Parity. Answer: PPP () states that the exchange rate between two countries' currencies equals the ratio of the countries' price levels.
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