Question

17. Does the behavior of the S- exchange rate support or contradict the theory of Uncov- ered Interest Parity? Answer with reference to the following Figure Dollar and euro 8 % interest rates 7 (% per year) Fed funds 6- rate, s 2F ECB refinancing 1 rate, is Exchange rate (S/e) $1.30 U.S. exchange rate, Esye (right axis) 1.20 | - 1.10 1.00 0.90 0.80 JanJan JanJanJJan 1999 2000 2001 2002 2003 2004 (a) Supports the theory of UIP. (b) Contradicts the theory of UIP. 18. Is the Fisher Effect more likely to hold in the short-run of the long-run? (a) In the short-run (b) In the long-run (c) Both in the short-run and the long-run (d) Cannot tell with given information.

Answer 1

17) Answer

In the above graph see we determine the When dollar interest goes up more than euro interest rate goes up then dollar should appreciate relative  to euro and when the dollar interest rate goes down more than euro interest rate dollar should depreciate as per the UIP.

Than we should , hence the figure shown does not follow this pattern for ex - Between 2002 and 2003 there is no Movement in interest rate but the exchange rate movement is there where in dollar depreciates .

Hence the answer is a) supports the theory of UIP and b) contradicts the theory of UIP both will correct and at times it is supporting and at times it is not.

18) Answer

In the fisher effect should on its to keep in mind that the Fisher effect is a phenomenon that appears in the long run but that may not be present in the short run. because the fisher effect indicates that the real interest rate equals the nominal interest rate less the expected rate of inflation.so answer is option b is in the  long run fishers effect on hold.