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ECON 352 International Finance
Assignment 1
August 8th, 2024
• This assignment is due on Thursday, August 22th at 3:00 pm.
• It must be submitted electronically via CANVAS as a single pdf file.
• It is worth 15 points or 15% of the final grade.
• Please, answer ALL THREE (3) questions available. Each question is worth 5 points.
• Please, use appropriate software to produce your plots and to write your answers.
• Make sure that all your sources of information are properly cited. Carefully document any manupulations with data you made to obtain the plots.
Question 1. (Relative PPP) In this question we will be testing an assumption of our model of exchange rate determination. In particular, you will be showing that the PPP assump- tion often fails in the short run, emphasizing the importance of the unifying approach discussed in Topic 4. Go to the website of Federal Reserve Economic Data (FRED) at https://research.stlouisfed.org/fred2/ and download annual data for Consumer Price Indices for the United States, Japan, and Canada. In addition, download annual data for the U.S. dollar exchange rate with the Canadian dollar and Japanese yen going back to 1971. Put each data series into a separate column in a new spreadsheet. (Hint: the following series should suffice:
• Organization for Economic Co-operation and Development, Consumer Price Index: All Items: Total for Japan [CPALTT01JPA657N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPALTT01JPA657N, August 6, 2024.
• Organization for Economic Co-operation and Development, Consumer Price Index: All Items: Total for Canada [CPALTT01CAA657N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPALTT01CAA657N, August 6, 2024.
• Organization for Economic Co-operation and Development, Consumer Price Index: All Items: Total for United States [CPALTT01USA657N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPALTT01USA657N, August 6, 2024.
• Board of Governors of the Federal Reserve System (US), Japanese Yen to U.S. Dollar Spot Exchange Rate [AEXJPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AEXJPUS, August 6, 2024.
• Board of Governors of the Federal Reserve System (US), Canadian Dollars to U.S. Dollar Spot Exchange Rate [AEXCAUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AEXCAUS, August 6, 2024.)
(a) We will want to check our assumption for relative PPP (that the difference in inflation between each of these countries and the United States should equal the change in the exchange rate). To do this you must first calculate the percent change in the spot exchange rate for each year. Do this for Japan and Canada with respect to the United States. In both cases, when did the largest appreciation occur? The largest depreciation?
(b) Now check relative PPP as stated in Equation 3-2(14-2) reproduced below:
Compute the difference in annual rate of inflation in these two pairs of countries (Canada and the United States, and Japan and the United States) and see if it is equal to the annual change in the exchange rate for the pair. Create a new column showing the magnitude of the deviation from relative PPP. Next, compute the mean and standard deviation for each country pair over the sample period. Are the means what you would expect them to be if PPP holds in the long run? What is the largest deviation from our PPP assumption?
(c) Create a line graph showing the deviations from relative PPP plotted against time in each case. Does it appear that these deviations are trending toward zero over time? What appears to be the longest time before a deviation from PPP returns to zero?
Question 2. (Hyperinflations) Consider any two hyperinflation episodes that took place after World War II. Make a short PowerPoint presentation (5-6 slides) that describe the key features of these events, their probable causes and consequences for the economy. Complement your slides with a brief discussion (1 page). What are the key differences between the two hypeinflation episodes? What are the key similarities? How did the episodes end? Which policies seemed to work and which seemed to fail?
Question 3. (Absolute PPP) Consider Figure 3-3 in the textbook (Slide 15, Topic 3).
(a) Use the data collected in Question 1 to replicate Figure 3-3 for the U.S. and Canada. Plot in the same graph the evolution of the nominal exchange rate and the relative price levels of the two countries. In a separate figure, plot the evolution of the real exchange rate. Does absolute PPP seem to hold? Why? (Hint: The price data collected in Question 1 represent annual percentage changes in consumer price indices (CPI), i.e. CPI inflation rates. In order to construct price levels, assume that in year 2000: (i) a consumption basket in U.S. costs USD 100.00 (PUS,2000 = 100) and (ii) absolute PPP holds: PCAN,2000 = PUS,2000/E USD/CAD,2000 . Now, you can compute the price levels for all years, using the definition of CPI inflation,e.g. PUS,2001 = PUS,2000 (1 + πUS,2001)).