1. a) If there is 10% inflation in Mexico, 15% inflation in Turkey, and the Turkish lira weakens by 20% relative to the Mexican peso, by how much has the lira strengthened or weakened in real terms? How would this change in the real exchange rate affect trade between the two countries?
b) One year ago, a Turkish firm borrowed 10 million Mexican pesos, which it will repay today. Did it gain or lose from the change in the value of the Mexican peso? Explain.
2. The government of Norden is committed to maintaining an exchange value for the Norden franc between $1 US = 4.1 francs and $1 US = 4.3 francs. The current exchange rate is $1 = NFr 4.3 and Norden's inflation rate exceeds the U.S. inflation rate substantially. The U.S. government does not share the commitment to a pegged franc/dollar exchange rate.
a) What actions on the part of Norden's central bank will be required to maintain an exchange rate in the target range?
b) Assume that Norden continues to peg the exchange rate while the inflation differential widens. Can this situation persist indefinitely? Explain.
c) What actions will profit seeking speculators take? Describe how speculators can profit from the situation.
3. If the Canadian dollar is appreciating against the Turkish lira in nominal terms but depreciating against the lira in real terms, what do we know about Turkish and Canadian inflation rates?
4. Assume the Japanese government relaxes its controls on imports by Japanese companies. Other things being equal, how should this affect the (a) demand for Japanese yen, (b) supply of yen, and (c) equilibrium value of the yen?
5. China's foreign exchange reserves rose by $130 billion during the first two months of 2008 as a result of the Chinese central bank's intervention in the foreign exchange market. Around two-thirds of China's foreign reserves are in dollars.
a) What does this suggest about the relationship between the observed yuan-dollar exchange rate and the yuan-dollar exchange rate that would have prevailed in the absence of the intervention, other things being equal? Why?
b) Suppose that the Chinese central bank had not intervened in the foreign exchange market and that Chinese policy makers had removed the capital controls that prevent the inflow of speculative money and Chinese citizens from undertaking many types of investments abroad. Can you predict confidently the relationship between the observed yuan-dollar exchange rate and the rate that would have prevailed in this case? Why or why not?
6. Interest rate parity between two currencies is more likely to be violated when one of the currencies is from a developing market than when both currencies are from developed markets. Discuss whether or not you agree with this statement.
7. When policy makers in an economy with a history of high inflation rates attempt to change their macroeconomic policies to lower inflation, they often cite declining long-term nominal interest rates as evidence that the policy change is working. Explain. Can you think of additional sources of information about the success of their policy change? Explain.
8. a) Can a country have a current-account deficit, capital-account deficit, and flexible exchange rate? Why or why not?
b) Can a country have a current-account surplus, capital-account surplus, and fixed exchange rate? Why or why not?
9. Consider a small open economy that is highly averse to inflation, but whose trading partners all have relatively high rates of inflation. Would that economy be better off operating with a fixed or a floating exchange rate regime? Explain.