Question

This question considers long-run policies in Turkey relative to its largest trading partner:

Europe. Assume Turkey’s money growth rate is currently 15% and Turkey’s output growth is 9%.

Europe’s money growth rate is 4% and its output growth is 3%. For the following questions, use the

conditions associated with the long run model. Treat Turkey as the home country and define the exchange

rate as Turkish lira per euro,

E

L/€

.

a. Calculate the inflation rate in Turkey.

b. Calculate the inflation rate in Europe.

c. Calculate the expected rate of change in

E

L/€

.

d. Suppose the Central Bank of the Republic of Turkey decreases the money growth rate from 15% to

11%. If nothing in Europe changes, what is the new inflation rate in Turkey?

e. Instead, suppose the Central Bank of the Republic of Turkey sought to implement policy that would

cause the Turkish lira to appreciate relative to the euro. What range of values does this imply for

Turkey’s inflation rate? What ranges of the money growth rate (assuming positive values) would

allow the central bank to achieve this objective?

Answer 1

Given that,

Turkey’s money growth rate -->15%

Turkey’s output growth --> 9%

And,

Europe’s money growth rate --> 4%

Europe’s output growth --> 3%

Growth of money - growth of output = growth of price (or, inflation)

(a) or, inflation rate in Turkey =15% - 9% = 6%

(b) and, inflation rate in Europe = 4% - 3% = 1%

(c) Depreciation = domestic interest rate - foreign interest rate

We also know,

Nominal interest rate = real interest rate + inflation

Hence for turkey,

Nominal interest = 1.75%+ 6%= 7.75% (Considering world interest rate be 1.75%)

And for Europe,

Nominal interest = 1.75+1%= 2.75% (Considering world interest rate be 1.75%)

7.75-2.75= 5%

i= 1.75%+6%= 7.75%

Nominal interest rate = real interest rate+ inflation

So, i= 1.75%+6%= 7.75%

Hence, Depreciation (relative to the euro) = 7.75% - 2.75% = 5%

(d) Now, the Central Bank of the Republic of Turkey decreases the money growth rate from 15% to 11%.

As, inflation = money growth - output growth

New inflation rate is (11% - 9%) = 2%

Please Note: As per HOMEWORKLIB RULES, I have answered of four sub questions. Kindly post the question number (e) separately. Thank You!