This question uses the Fisher relationships and the theory of uncovered interest parity. Suppose expected inflation in t...
This question uses the Fisher relationships and the theory of
uncovered interest parity. Suppose expected inflation in the U.S.
is 2% and expected inflation is 3.2% in the eurozone. The real
interest rate is 1.4%. What is the expected change in the value of
the euro?
Homework Answers
Euro interest rate = real rate + inflation = 1.4%+3.2%=4.6%
US interest rate = real rate + inflation = 1.4%+2%=3.4%
Expected % change in value of Euro = Euro interest rate - US interest rate / (1+ US interest rate) = 4.6%-3.4% / (1+3.4%) = 1.16% depreciation (since inflation in Euro is more than US)
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