Exhange Rate Determination

Hi guys, If anyone is working on Chapter 19, I would appreciate some clarification. Example 9: In the solution for the long run exhange rate, they use this formula: S*= 1 X 1.02/1.000= 1.02 dollars per euro I was wondering if anyone knew where they got this formula and what the numbers stand for. the 1.02 is the new price level after the money supply increase. What about the other two 1.0? Are they the euro/usd exchnage rate or is it the price level prior to the money supply increase? Any thoughts would be greatly appreciated. Regards

I was wondering about the same formula… I think the 1.000 is the price level and the 1 is the old exchange rate… The formula probably stems from PPP which states that S1/S0=(1+foreign inflation)/ (1+domestic inflation) Correct me if wrong!

You could be right. I’m going to give the end of chapter questions a try and see… what about the rest of the questions? Why are the numbers squared? I looked over the chapter several times and I still don’t see anywhere that they should be squared. Am I missing something?

Could you post the question?

My understanding is this formula is from page 698 formula #(9) uncovered interest rate parity. s* stands for Spot rate. 1 = E(s) 1.02 = US price level will rise by 2% to 1.02 1.0 = Europe price level (no change)

The number squared because it is expected that it will take two years for the shock in money supply to translate fully into a price increase.