DePaul University Eurozone Inflation Rate & Foreign Exchange Graphs

PART I:Graphical Exercises.You must show your work.Not showing your work will get you zero points on the question, even if your answer is correct!!(13 points)

• Draw and carefully label the Euro-U.S. dollar foreign exchange graph as discussed in the textbook.Assume we are currently in market equilibrium.Illustrate using the graph how the equilibrium euro/dollar foreign exchange rate would be affected by the following events, holding all else constant.Explain in words why the equilibrium exchange rate changed. (8 points)

• An increase in US short-term interest rates while Euro interest rates were unchanged.
• A decrease in the Eurozone inflation rate relative to the US.

2.Assume Egypt has pegged its currency to the Euro, but high inflation in Egypt relative to the Euro Area has caused its currency (the Egyptian Pound) to be overvalued. The Egyptians cannot borrow internationally and the exchange rate has come under pressure. What are the options available for Egypt to deal with the crisis? Why might Egypt go to the IMF for a deal?What can the IMF do for Egypt and what would Egypt need to do for the IMF? (5 points)

Part II:Identifications (12 points)

Define and explain the importance of three of the four following concepts.

Bretton Woods SystemLender of Last Resort

Purchasing Power ParityInflation Targeting