The absolute purchasing-power parity theory: The theory that postulates that the equilibrium exchange rate between two currencies is equal to the ratio of the price levels in the two nations.

The relative purchasing-power parity theory: The theory that postulates that the percentage change in the exchange rate is equal to the difference in the percentage change in the price levels in the two countries.

The law of one price: The proposition that in the absence of transportation costs, tariffs, and other obstructions to the free flow of trade, the price of each homogenous (identical) traded commodity will be equalized in all markets by commodity arbitrage. Exchange rate overshooting: The tendency of exchange rates to immediately depreciate or appreciate by more than required for long-run equilibrium, and then partially reversing their movement as they move toward long-run equilibrium levels. The trade or elasticity approach: Postulate that the equilibrium exchange rate is the one that balance the value of the nation’s import and exports.

The monetary model exchange rates: The theory that postulates that exchange rates are determined in the process of equilibrium or balancing the stock or total demand and supply of money in each nation. (an increase in the nation’s money supply leads to an equal increase in price and depreciate of the nation’s currency in the long-run.) The asset or portfolio model: The theory that postulates that an increase in a nation’s money supply leads to an immediate decline in the interest rate and shift from domestic bonds to the domestic currency and to foreign bonds.

Stable foreign exchange market: The condition in a foreign exchange market where a disturbance from the equilibrium exchange rate gives rise to automatic forces that push the exchange rate back toward the equilibrium rate.

J-curve effect: The deterioration before a net improvement in a country’s trade balance resulting from a depreciation or devaluation. The reason is that it takes time to order,ship,receive,and utilize goods.In fact,the immediate effect of a depercistion may be to worsen,rather than improve,the nation’s trade balance because the price of imports usually rises sooner and faster than the price of exports.

Price-specie flow mechanism: The automatic adjustment mechanism under the gold standard. It operates by the deficit nation losing gold and experiencing a reduction in its money supply. （双向流动）This in turn reduces domestic prices, which stimulates the nation’s exports and discourages its import until the deficit is eliminated A surplus is corrected by the opposite process.

Expenditure-changing polices: Fiscal and monetary policies directed at changing the level of aggregate demand of the nation.

Expenditure-switching polices: Devaluation or revaluation of a nation’s currency directed at switching the nation’s expenditures from foreign to domestic or from domestic to foreign goods.

Freely floating exchange rate system: The flexible exchange rate system under which the exchange rate is always determined by the forces of demand and supply without any government intervention in foreign exchange markets.

1.（a）What is the absolute purchasing-power parity theory? Why is this not acceptable?The theory that Postulates that the equilibrium exchange rate between

two currencies is equal to the ratio of the price levels in the two nations. R=P/Pf.If there were no transportation costs, tariffs, and other obstructions to the free flow of trade,if all commodities were trade internationally and if no strutural changes took place in us ,since there assumptions do not hold the absoluted version of the ppp can not be taken seriously.

(b)What is the relative purchasing-power parity theory? When do we expect it to hold? The theory that postulates that the percentage change in the exchange rate is equal to the difference in the percentage change in the price levels in the two countries.2We expect the relative purchasing-power parity theory to be approximated in the long run.

(c). Do empirical tests confirm or reject the relative purchasing-power parity theory? 经验检验是肯定的还是拒绝相对购买力平价理论Not much except in the long run. But this doesn’t mean the theories are useless. It just simple means that they provide incomplete explanation of exchange rate determination.

2. In 1973 the Consumer Price Index was 15.9 in the United Kingdom and 29.2 in the United States from 1973 to 20xx, it was 122.4 in the United Kingdom and 121.5 in the United States. The exchange rate was ￡0.04304 to the dollar in 1973 and ￡0.5975 to the dollar in 20xx.

19xx年英国的消费价格指数为15.9，美国的该指数为29.2 20xx年该值在英国为122.4 美国121.5 两国的汇率在19xx年为￡0.04304 20xx年为￡0.5975

(a). Calculate the rate of inflation in the United Kingdom minus the rate of inflation in the United Stated from 1973 to 20xx and compare it with the rate of depreciate of the Britain pound with respect to the U.S. dollar over the same time period. 计算一下1973到20xx英国和美国的通货膨胀率之差，并将它与同期英镑对美元的贬值情况进行对比 R=P – Pf =(122.4-15.9/15.9)-(121.5-29.2/29.2)=3.537

( 0.5975-0.4304)/0.4304=0.3882

(b). Did the relative purchasing-power parity theory hold between the United States between 1973 and 20xx? Why? 1973到20xx年在美国和英国之间，相对购买力平价理论有效吗，为什么？According the relative purchasing-power parity theory the higher the price level is the greater the pressure of depreciate, so the conclusion of (a) provides supply for the Relative purchasing-power parity theory because of the equation of R=P-Pf

3. (a) Explain what is the effect on the exchange rate of an increase in the nation’s money supply according to the monetary model.根据货币模型，解释一国货币供给增加对汇率有何影响 MS (increase) → rate (decrease) → out flow (increase) → home currency (depreciate)

(b) Do empirical tests support or reject the monetary? 实证研究支持还是拒绝货币模型？资产市场或资产组合方法呢？Not much except in the long run. But this doesn’t mean the theories are useless. It just simple means that they provide incomplete explanation of exchange rate determination.

4. (a) Explain what is the effects on the exchange rate of an increase in the nation’s money supply according to the asset market or portfolio model. 根据资产市场或资产组合货币模型，解释一国货币供给增加对汇率有何影响

MS (increase) → rate (decrease) → out flow (increase) → home currency (decrease) → ↗export (increase) ↘ import (decrease) → surplus → appreciate

(b). In what way does it differ from the monetary approach?它在那些方面与货币分析法不同 The asset or portfolio model of exchange rates differs from the monetary approach by postulating that the exchange rate determined in the process of equilibrating or balance the stock or total demand and supply of financial asset (of which money is only one) in each country. It also brings trade explicitly into the analysis.

(c). Do empirical tests support or reject the portfolio approach? 实证研究支持还是拒绝货币模型？资产市场或资产组合方法呢？ Not much except in the long run. But this doesn’t mean the theories are useless. It just simple means that they provide incomplete explanation of exchange rate determination.