Chase Econometrics has just published projected inflation rates for the US and G
ID: 2808998 • Letter: C
Question
Chase Econometrics has just published projected inflation rates for the US and Germany for the next three years. US inflation is expected to be 2.5 percent per year and German inflation is expected to be 1.0 percent per year. a. If the current spot exchange rate is US$1.2383/€, what would you expect the spot rate to be in three years if purchasing power parity holds? b. If you expect the nominal spot exchange rate to still be US$1.2383/€ in three years, in which currency would you prefer to invest now?
Explanation / Answer
a). According to PPP, the exchange rate for the euro at the end of year 3 should be
= 1.2383(1.025/1.01)3 = 1.2383 x 1.04522 = $1.2943/€
b). if exchange rate is $1.2383/€ in three years, then euro would be preferred for investment.