Discuss the relationship between the u.s. real money supply, International Economics

Q. To answer the following question, please refer to the figure below. Concentrating only at the lower left quadrant, discuss the relationship between the U.S. real money supply and the dollar/euro exchange rate, E$/E.

1513_Discuss the relationship between the U.S. real money supply.png

Answer: The lower left quadrant in the figure described the PPP (Purchasing Power Parity) relationship. The relationship with the U.S real money supply and the dollar/euro exchange rate E$/E is negative.s

E$/E is equal to the price level ratio PUS/ PE in this derivation of the relationship the following variables are assumed constants,

M1US, RE, and PE

So, E$/E = M1US/PUS

The raise in PUS leads to a positive increase in E$/E.

P1US will shift to P2US

Therefore the purchasing power of the dollar decreases because of the increase in the price level.

E1$/E will shift to E2$/E

Explicitly the dollar depreciates due to PPP.

Posted Date: 6/27/2013 8:33:37 AM | Location : United States







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