Latvia is a small country in Northern Europe on the Baltic Sea. Latvia joined the European...
- Latvia is a small country in Northern Europe on the Baltic Sea. Latvia joined the European Union in 2004 and adopted the euro as its currency in 2014. The questions below refers to the time period before 2014, when Latvia pegged its currency to the euro.
Suppose Latvia credible pegs its currency to the euro which means that the rate of depreciation of its currency is expected to be 0 with ELVL/€ = EeLVL/€). Its currency, the lats (LVL), are fixed to the euro at a rate of ELVL/€ = 0.708, with no capital controls. The expected annual inflation rate in the Eurozone is 6%, and the current interest rate on euro deposits is i€ = 7.25%. Use the complete theory of exchange rates to answer the following questions.
A year from now, the lats/euro exchange rate is expected to be: ______________ (numerical value).
The current interest rate in Latvia is __________(numerical value in %) .
The expected annual inflation rate in Latvia is ___________(numerical value in %) .
Given the exchange rate regime in Latvia, indicate for each of the following variables whether the country’s monetary authority can control it in the short-run, the long-run, or neither. Place a mark in the appropriate box.
|
Short-Run |
Long-Run |
Neither |
|
|
Money Supply |
|||
|
Interest on lats deposits |
|||
|
Inflation Rate |
|||
|
Lats/euro exchange rate |
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