International Parity Conditions

| Textbook pages 6-9. We assume that the currency will be stable over time. Inflation is an example.

Currency exchange rates can be categorised as floating, in which case they constantly change based on a number of factors, or they can subsequently be fixed to another currency, where they still float, but they additionally move in conjunction with the currency to which they are pegged. Floating rates are a reflection of market movement, demonstrating the principles of both demand and supply, as well as limit imbalances in the international financial system. Fixed exchange rates are predominantly used by developing countries as they are preferred for their greater stability. They grant further control to central banks to set currency values, and are often used to evade market abuse. (MacEachern, A. 2008; Simmons, P.

There are also many economists who would agree with the claim that zero inflation is the optimal rate of inflation. This claim employs

3) Purchasing power parity and the exchange rate in the long run (how exchange rate is

If the annual inflation rate is 3.5 percent in the United States and 2 percent in the U.K., and the dollar depreciated against the pound by 2.5 percent, then the real exchange rate, assuming that PPP initially held, is:

The Lord’s role in the book of Exodus begins from the early childhood of Moses. Soon after Moses’s birth, King Pharaoh ordered for all the male children to be killed (Watt, 1997). The Lord saved baby Moses from Pharaoh since he would later use him to evacuate the Israelites to the promised land of Canaan. Moses, as a herder, would then in life see a burning bush, from where the Lord spoke to him and instructed to go and tell Pharaoh that he wanted to free the Israelites from bondage in Egypt (Nelson, 1993). 1.

During the second half of 1997, currencies and stock market prices plunged in value across Southeast Asia, beginning in

The black market rate of Rp 50.00/U.S.$ represented a devaluation from the current rate of Rp40.4795/$ of about 23.5%.

(1) Peso/$US rate would remain constant - despite stable projection of peso exchange rate till 1998, PPP implied exchange rate has a high range (0.999-1.436, 44%) and hence significant volatility.

Such a process can be very time consuming and imprecise, without, of course, having a market currency price to begin with. The exchange-rate system is an important topic in international economic policy. Policymakers and journalists often seem to treat the choice of exchange-rate system as one of the most important economic policy choices that a national government makes, on a par with free international trade. Under most circumstances and for most countries, a system of freely floating exchange rates is likely to be a better choice than attempting to peg the exchange rate.

Exhibit 3 shows that Mexican GDP at PPP has had a constant growth since 2001, except for 2009 when it fell down suffering the effect of the crisis that affected the U.S. since 2008. From 2001 to 2009 the CAGR for GDP at PPP resulted around 5.5%, and after a 6.5% loss in 2009 the economy has returned to grow at around 5% annually and the GDP is expected to increase in the future at an higher rate, allowing Mexico to overcome Italy in the G20 ranking (Euromonitor International, January 2011).

Real GDP can be calculated with the use of prices derived from a given base year, and this helps in the adjustment to changes in price. Through this perspective, it becomes possible for the real GDP to measure accurately changes relating to output

The issue of whether PPP holds has been subject to substantial controversy. It is well known that PPP holds better, among other things, for long span data. One way to test for the validity of PPP is to test whether real exchange rate has unit root or not. Knowledge of the stochastic structure of real exchange rates is useful in determining whether shocks to real exchange rates are permanent or transitory, and if transitory, whether they are predominantly monetary or real shocks. Perhaps, the strongest evidence for PPP in this sense is provided by Taylor (2002), who employed a century of real exchange rate data for 20 countries against the US dollar and a “world” basket of currencies, and concluded that “PPP has held in the long run over the twentieth century for my sample of 20 countries”. Taylor reached this conclusion by using a more powerful test, namely, Dickey-Fuller (DF)-Generalized-Least-Squares (GLS) test of Elliott, Rothenberg and Stock (1996), rather than the standard augmented DF (ADF) tests. His results were not sensitive to using a different base currency (the U.S. dollar or the “world” basket) either. Taylor’s findings were also robust to employing either industrial countries or developing countries.1 As a result, Taylor stated that “If PPP holds in the long run, it is no longer productive to devote further the

Many other academics have attempted to do empirical studies to confirm that there is really a force that exchange rate has driving the (un-) employment level to correspond to the changes.

Current spot rates………………………………….… Purchasing power parity forecasts…………….…… International Fisher forecasts………………………. Implied real interest rates…………………………… Forecasting with real interest rates………….…….. Forward rates………………………………….……… Real economic activity and misery………….……… Balance of payments approach……………….……. Current