Problem Statement Nowadays, most countries are involved i

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Problem Statement Nowadays, most countries are involved in international trade, which requires them to convert their currencies into other countries’ currencies to make investments, and/or export or import goods

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Problem Statement

Nowadays, most countries are involved in international trade, which requires them to convert their currencies into other countries’ currencies to make investments, and/or export or import goods. An essential task of economists in any country is the exchange rate determination (or prediction). Fluctuations in the exchange rate, the prices many households pay to obtain foreign-made goods and services are known as imports. For instance, in 2019, the total value of US exports was 1.7 Trillion dollars, and the total value of US imports was 2.5 Trillion dollars.

How is the exchange rate determined?

In the short run, the exchange rate is determined through the interaction of the supply and demand of one currency in exchange for another currency. In the long run, however, the exchange rate is determined using the theory of the Purchasing Power Parity (PPP).

What is the theory of the Purchasing Power Parity (PPP)?

The theory of PPP is the economic principle that states that exchange rates move to equalize different currencies' purchasing power. Economists base the PPP on the fundamental economic idea of The Law of One Price. The Law of One Price states that similar products should sell for the same price everywhere. Price differentials create opportunities for arbitrage profits consisting of moving a product from the low-price market to the high price market until an increase in demand in the low-price market and increase in supply in the high-price market work to eliminate price differentials.

What is the main prediction of the PPP?

The main prediction of the PPP is that the rate of growth of the exchange rate of a currency in terms of another currency is equal to the inflation rate differentials between two countries.

Assignment

Part 1

· Belgium and Switzerland are two countries that are economically similar in terms of their GDP per capita, unemployment rates, and inflation rates. For instance, the US and Canada can be considered economically similar. The price index to be used can be the Consumer Price Index (CPI) or the GDP Deflator. You can visit the website Global Economy.com to easily compare countries to check for similarity - https://www.theglobaleconomy.com/compare-countries/

· Then use the price indices and the exchange rate of these two countries' currencies data to verify the evidence of the theory of PPP.

Data

The data on exchange rate between the two currency can be found at:

The 2020 World Development Indicators (WDI) data which include https://www.ofx.com/en-us/forex-news/historical-exchange-rates/yearly-average-rates/

price indices can be found at:

https://databank.worldbank.org/source/world-development-indicators

A clean version of the latter is attached.

Helpful Resource:

The following YouTube is created to help give you further guidance with Part 1 and the beginning of Part 2 -https://youtu.be/7XdYdK07D1k

Part 2

Task One

Calculate the rate of growth of the exchange rates between two currencies using exchange rate data on your selected countries. Before doing so, please answer the following question.

What is the rate of growth and which formula is used to calculate it?

Display the rates of growth of the exchange rates between the two currencies of your selected countries in Excel or SPSS or Tableau chart/graph over the period 1999-2020.

Task Two

Calculate the inflation rates in each of your two selected countries using the Consumer Price Index (CPI) from the 2020 WDI data. Remember the inflation rate is the rate of growth of the CPI.

Display the inflation rates of your selected countries in Excel or SPSS or Tableau chart/graph over the period 1999-2020. Then answer the following question.

Which of your two selected countries has the higher rate of inflation based on the CPI?

Task Three

Calculate the inflation rates in each of your two selected countries using the GDP Deflator from the 2020 WDI data. Remember the inflation rate is the rate of growth of the GDP Deflator.

Display the inflation rates of your selected countries in Excel or SPSS or Tableau chart/graph over the period 1999-2020. Then answer the following question.

Which of your two selected countries has the higher rate of inflation based on the GDP Deflator?

Task Four

Calculate the difference between your two selected countries CPI based inflation rate. This difference is the predicted rates of growth of the exchange rate over the period 1999-2020.

Also, calculate the difference between your two selected countries GDP Deflator based inflation rate. These differentials are also known as the predicted rates of growth of the exchange rate over the period 1999-2020.

Display the predicted rates of growth of the exchange rate of currencies of your selected countries (from both the CPI and the GDP Deflator) in Excel or SPSS or Tableau chart/graph over the period 1999-2020. Then answer the following question.