Question

In the long run, exchange rate movements are driven by monetary factors( which determine general rates of

inflation in countries) and by microeconomic factors ( especially those that contribute to changes in the relative prices of traded to non traded goods). Using the United States and Europe to illustrate, make up numbers on average annual rates of price inflation and put them into the table below. Then use the information to predict what would happen to the euro per dollar exchange rate over the period. When making up the numbers, follow these two guidlines:

– Despite equal political pressure to print money to help manage deteriorating government budget positions, assume that the European Central Bank is more successful than the Federal Reserve in maintaining a low rate of overall price inflation.

– When people get older, they spend a larger percentage of their budget on services(which are non traded) and a smaller percentage on goods(which are traded). Over the next 20 years, the median age of the population in Europe is projected to rise more rapidly than will the mdian age in the U.S.. This means that the relative price of non traded goods to traded goods will rise more rapidly in Europe than in the U.S.

A) Based on information above, we can expect that over the period 2015-2035, the average annual percentage change in the euro per dollar nominal exchange rate will be____?

B) Suppose that the real exchange rate is measured as the price of all U.S. goods (traded and non traded) relative to, or divided by, the price of all European goods. Then what would you expect the average annual percentage change in the real exchange rate to be?

Note!!!: The underlined portion in the first paragraph details what you need to do in order to fill out the table, use the guidelines that are stated above the table. 

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