Question

You observe that the inflation rate in the United States is 1.4 percent per year and that T-bills currently yield 1.9 percent annually. Use the approximate international Fisher effect to answer the following questions.

a. What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 9 percent per year? (Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.)
Inflation rate_____________ %
b. What do you estimate the inflation rate to be in Canada, if short-term Canadian government securities yield 12 percent per year? (Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.)
Inflation rate___________ %
c. What do you estimate the inflation rate to be in Taiwan, if short-term Taiwanese government securities yield 10 percent per year? (Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.)
Inflation rate_________ %

Answer 1

Answer:

(a) 8.47%

(b) 11.45%

(c) 9.46%

Explanation:

International Fisher effect is as follows:

$\frac{1+ih}{1+if}=\frac{1+ph}{1+pf}$

where,

ih = Nominal interest rate of home country

if = Nominal interest rate of foreign country

ph = Inflation rate of home country

pf = Inflation rate of foreign country

(a) Inflation rate to be in Australia, if the short-term Australian government securities yield 9% per year,

$\frac{1+ih}{1+if}=\frac{1+ph}{1+pf}$

$\frac{1.019}{1.09}=\frac{1.014}{1+pf}$

1 + pf = 1.0847

pf = 1.0847 - 1

   = 0.0847 or 8.47%

Therefore, the inflation rate in Australia is 8.47%.

(b) Inflation rate to be in Canada, if short-term Canadian government securities yield 12 percent per year,

$\frac{1+ih}{1+if}=\frac{1+ph}{1+pf}$

$\frac{1.019}{1.12}=\frac{1.014}{1+pf}$

1 + pf = 1.1145

pf = 1.1145 - 1

   = 0.1145 or 11.45%

Therefore, the inflation rate in Canada is 11.45%.

(c) Inflation rate to be in Taiwan, if short-term Taiwanese government securities yield 10 percent per year,

$\frac{1+ih}{1+if}=\frac{1+ph}{1+pf}$

$\frac{1.019}{1.1}=\frac{1.014}{1+pf}$

1 + pf = 1.0946

pf = 1.0946 - 1

   = 0.0946 or 9.46%

Therefore, the inflation rate in Taiwan is 9.46%.