Question: Assume the prices indexes in Spain and the U.S are at 100 in January 1981 and at 117 and 105, respectively, in May 1981. Assume the peseta is worth $0.1320 in January 1981 and $0.1185 in May 1981.
a) Verify that the change in the nominal exchange rate ($/PS) is approximately equal to the inflation differential between the two countries.
You discover that your Professor was distracted and reported an incorrect nominal exchange rate. In May 1981, the correct exchange was PS1 = $0.1125.
b) Was the nominal depreciation of the peseta against the U.S. dollar larger, smaller or equal to the PPP prediction between January and May 1981? Was the peseta undervalued or overvalued relative to the U.S. dollar in May 1981?
c) What was the real exchange rate for the peseta in May 1981?
d) Did the peseta appreciate or depreciate against the U.S. dollar in real terms over the period? By how much?
e) What are the implications of your findings for Spanish exporters?
f) Compare the dollar price of a basket of Spanish goods in January 1981 to the dollar price of the same basket in May 1981. Verify that your answer in i) is correct.