Question

Argentine Tears. The Argentine peso was fixed through a currency board at Pst.00/' throughout the 1990 s. In January 2002 the Argentine peso was floated. On January 29 , 2003 i was trading at Ps3. 16/s. During that one yoar period Argentina's inflation rate was 19% on an annualized basis, Inflation in the United States during that same period was 2.2% annualized. a. What should have been the exchange rate in January 2003 if PpP held? b. By what percentago was the Argentine peso undervalued on an annualized basis? c. What were the probable causes of undervaluation? a. What should have been the exchange rote in January 2003 it ppp held? b. By what percentage was the Aggentine peso undervalued on an annualized basis? On an annualized basis, the Argentine peso was undervalued by 13.

Answer 1

In January 2003, the exchange rate of the Argentine peso should have been Ps3.68 if purchasing power parity held. The Argentine peso was undervalued by approximately 14.13% on an annualized basis. The causes of undervaluation can be attributed to factors like inflation, economic conditions, investor confidence, and market forces.

Step-by-step explanation:

In January 2002, the Argentine peso was floated which means its value was determined by supply and demand rather than being fixed. In January 2003, the exchange rate was Ps3.16/s, but if purchasing power parity (PPP) held, the exchange rate should have been different. PPP suggests that the exchange rate should reflect the relative prices and inflation rates between two countries. Since Argentina's inflation rate was 19% and the United States' inflation rate was 2.2%, we can calculate the expected exchange rate.

To calculate the expected exchange rate, we can use the formula:

Expected exchange rate = (1 + Argentina's inflation rate) / (1 + US inflation rate) * Previous exchange rate

Expected exchange rate = (1 + 0.19) / (1 + 0.022) * 3.16

Expected exchange rate = 3.16 * 1.19 / 1.022

Expected exchange rate = 3.68

Therefore, if PPP held, the exchange rate in January 2003 should have been Ps3.68. This means that the Argentine peso was undervalued.

To calculate the percentage by which the Argentine peso was undervalued on an annualized basis, we can use the formula:

Percentage undervalued = (Expected exchange rate - Actual exchange rate) / Expected exchange rate * 100%

Percentage undervalued = (3.68 - 3.16) / 3.68 * 100%

Percentage undervalued = 0.52 / 3.68 * 100%

Percentage undervalued ≈ 14.13%

Therefore, the Argentine peso was undervalued by approximately 14.13% on an annualized basis.

The probable causes of undervaluation could be due to various factors such as the impact of inflation on the currency's buying power, economic conditions, and investor confidence. Additionally, market forces such as supply and demand can also influence the exchange rate.