Suppose the Real Exchange Rate X Between Canada and the U.S

question 176

Essay

Suppose the real exchange rate X between Canada and the U.S. is constant. Let the price level in Canada be P, the price level in the U.S. be P*, and the nominal exchange rate bee. Suppose the price level in Canada increases from P₁ to P₂ and the price level in the U.S. increases from P₁* to P₂*. Show that the rate of change in e, which is equal to (E₂ - E₁)/E₁ × 100 is approximately equal to the difference in the inflation rates in the two countries. Note that the nominal exchange rate is e = XP*/P. What have you learned from this exercise?

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