Suppose the Swiss franc is worth $0.40 at the beginning of the year. During the year, U.S. inflation is 5% and Swiss inflation is 3%.
a) Does economic theory predict an appreciation or a depreciation of the Swiss franc over the year? Why? By how much approximately?
Suppose the Swiss franc is worth $0.44 at the end of the year.
b) By how much did the nominal value of the Swiss franc change over the year? Does your answer confirm or disprove the prediction of economic theory?
c) Does your answer in b) imply a change in the competitiveness of Switzerland relative to the United States? Why?
d) Compute the real value of the Swiss franc relative to the U.S. dollar at the end of the year.
e) The real exchange rate at the beginning of the year equals the nominal spot rate. Compute the change in the real value of the Swiss franc over the year.
f) Verify that the real percentage change in the exchange rate (answer d) equals the difference between the nominal percentage change in the exchange rate (answer b) and the inflation rate differential between the two countries.