This question considers long-run policies in Turkey (T) relative to its largest trading partner: Europe (E). Assume Turkey’s money growth rate is currently 15% and Turkeys 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 simple monetary model. Treat Turkey as the home country and define the exchange rate as Turkish lira per euro, ET RY /EUR.
(a) Calculate the inflation rate in Turkey.
(b) Calculate the inflation rate in Europe.
(c) Calculate the expected rate of depreciation of the Turkish lira relative to the euro.
(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) (optional) Illustrate how the change in part
(d) affects the following variables: MT , PT , MT /PT , ET RY /EUR.
(f) 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 ranges of the money growth rate (assuming positive values) would allow the central bank to achieve this objective? What range of values does this imply for Turkeys inflation rate?