Question

Argentine Float. The Argentine peso was fixed through a currency board at Ps1.00/$ throughout the 1990s. In January 2002, the Argentine peso was floated. On January 29, 2003, it was trading at Ps3.19/$. During that one-year period, Argentina's inflation rate was 21% on an annualized basis. Inflation in the United States during that same period was 2.2% annualized. a. What should have been the exchange rate in January 2003 if PPP held? b. By what percentage was the Argentine peso undervalued on an annualized basis? c. What were the probable causes of undervaluation? a. What should have been the exchange rate in January 2003 if PPP held? The exchange rate in January 2003, if PPP held, should have been Ps$. (Round to five decimal places.) b. By what percentage was the Argentine peso undervalued on an annualized basis? On an annualized basis, the Argentine Peso was undervalued by %. (Round to three decimal places and include a negative sign if needed.) c. What were the probable causes of undervaluation? (Select the best choice below.) O A. The rapid increase in the value of the U.S. dollar was a result of not only inflation, but also a severe crisis in the balance of payments B. The rapid decline in the value of the Argentine peso was a result of not only inflation, but also a severe crisis in the balance of payments. C. The rapid decline in the value of the U.S. dollar was a result of not only inflation, but also a severe crisis in the balance of payments. D. The rapid increase in the value of the Argentine peso was a result of not only inflation, but also a severe crisis in the balance of payments.

Answer 1

a. In 2003 the floated exchange rate should be =Exchange rate in 2002*(1+Argentina Inflation)/(1+US Inflation)
=1*(1+21%)/(1+2.2%) =1.18395

b. The Argentina Peso Was Under Valued by =(1.18395-3.19)/3.19 =-62.886%

c. Option d is correct option This devaluation could be due to both deflation and balance of payment crisis.