Example 4.2 Suppose that the (gross) rate of return on fiat money in the United

Question

Example 4.2 Suppose that the (gross) rate of return on fiat money in the United States (country a ) is 2.0 and that of Canada (country b ) is 1.0. The (gross) growth rate of the Canadian population ( n b ) is 1.2. Foreign exchange controls are in effect.

a. What is the time path of the exchange rate ( et+1 / et )?

b. Suppose that Canada wishes to maintain a fixed exchange rate with the United States.To accomplish this goal Canada must set its gross rate of fiat money creation ( zb ) to what value?

Explanation / Answer

answer a

( et+1 / et ) = (zb/za*nb)=1/(1.2*2)=0.416

answer b

zb= za*nb= 1.2*2=2.4

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