This question considers long-run policies in Algeria. Assume Algeria's inflation rate is 6% and money growth rate is 7%. During the same period, Italy has a real income growth rate of 1% and inflation rate is 2%.
Use the associated conditions of the long run money market and exchange rate models to answer below questions. Treat Algeria as the home country. The exchange rate is defined as Algerian dinar per euro, ED/E.
1) What is the real income growth rate in Algeria?
2) What is the nominal interest rate in Italy?
3) What is the expected rate of depreciation in dinar per euro?
4) Suppose that Algeria wants to implement a fixed exchange rate regime and fix the value of dinar against the euro.
- What money growth rate must the central bank pick to achieve this objective?
- What would be the new inflation rate and the nominal interest rate after this policy change?
5) Suppose Italy experiences an increase in real income growth rate, and it is now 2%. If Algeria wants to maintain the fixed exchange rate regime, what would happen to its inflation rate.