Question

The exchange rate between the British pound and the U.S. dollar is 2. In England, the price level is 1.0 and the one-year interest rate is 20%. In the United States, the price level is .8 and the one-year interest rate is 8%. The inflation rate in both countries is zero. Refer to the information above. The real exchange rate (from the United States' perspective) is _________.

a. .625.
b. .8.
c. 1.6.
d. 2.0.
e. none of the above

Answer 1

C) 1.6

Step-by-step explanation:

The real exchange rate is calculated by multiplying the nominal exchange rate by the price level of the countries:

nominal exchange rate = 2 US dollars per British pound = $2/£

real exchange rate = $2/£ x (US price level / British price level) = $2/£ x 0.8 = $1.6/£