Practice Problem #5
11. A German owns a bond that will pay N2030 = €$100 in 2030. The objective of the
European Central Bank is to have “The primary objective of the ECB’s monetary policy is to
maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium
term.” http://www.ecb.int/mopo/html/index.en.html Calculate the purchasing
power of the future payoff in 2010 prices if the ECB always achieves a 2%
inflation rate, 1  gtP  1.02 . (Hint If a variable X has the same growth rate g
every year, X t T  (1  g )T X t ). In 2010, IMF Chief Economist Olivier Blanchard
Link suggested that central banks should increase the inflation target to 4%.
Calculate the purchasing power of the future payoff in 2010 prices if the ECB
achieves a 4% inflation rate.
12. Currency Misalignment. Calculate the over or undervaluation of some Asian
currencies. . Go to World Bank World Development Indicators and hit
. Choose
and
China, Korea, Rep., and Thailand. Hit
and then
. From
and
PPP conversion factor, GDP (LCU per international $) , and PPP conversion
factor, private consumption (LCU per international $),
From
and
DEC
alternative conversion factor (LCU per US$) (a measure of the exchange rate).
Hit
and
2005 and 2010.
a. Compare the exchange rate with the price of goods. Using this as a measure of the
competitiveness of the goods in this country, are these currencies under or overvalued in 2005 and 2010.
b. Trade in capital equipment constitutes a large fraction of international trade.
Consider the relative price of equipment and machinery. Go to International
Comparison Program. Go to the World Data Bank at the World Bank. Choose
International Comparison Program(2005).
Hit
and
China, Korea, Rep., and Thailand. Hit
and choose 1501 Machinery and Equipment. Hit
and
choose Exchange rate (LCU per US$, period average), PPP (LCU per international
$), Choose 2005 and hit
. Shift Classification to Page.
Choose
and
to export to Excel. Compare the
exchange rate with PPP. Using the relative prices of capital equipment, which
currency is under- or over-valued..
c. What problems might be present in either measure of over or under-valuation?
d. The data is not up to date. Calculate a PPP conversion factor for Equipment and
Maintenance for Korea and United States for 2010. To get information on
potential GDP go to OECD Stats Abstracts and choose from the left hand side bar
. Choose
and press
Choose
.
.
and
. Choose
&
.
Choose
Time
and
. Press
From
to Horizontal Dimensions and Transaction and Measure to Vertical Dimensions .
Choose
i.
Shift
. To work with the data in Excel, export using
then choose
.
For each time period, construct the aggregate level of equipment
Vt EQ  vt31  vt32 as the sum of current prices measure of j = 31 and 32
(31 = transportation and 32 = other equipment).
ii.
Construct the implicit price deflator or aggregates j = 31 and 32,
Pt j as the ratio current to constant price expenditure
iii.
Calculate the price trajectory
ptj
ptj1
for each type at time t.
32
iv.
Calculate the aggregate volume growth, 1  gtQ 
v
j 31
t
j
 pt 1 ptj
j
Vt EQ
1
1  gtV
.
1  gtQ
vi.
Calculate the relative PPP of equipment in Korea 2010 as
P
P
P
(1  g 2007,
(1  g 2010,
KOR )
KOR )
KOREA
KOREA (1  g 2006, KOR )
PPP2010  PPP2005 


P
P
P
(1  g2006,
(1  g 2007,
(1  g 2010,
USA )
USA )
USA )
vii.
Compare this relative price with the Won-Dollar exchange rate. By
this measure, is the Won undervalued?
v.
Calculate the growth of equipment prices as 1  gtP 