Question

Use the peso real exchange rate index below to answer the questions that follow. (1) What happened to the purchasing power of the peso from 1991 to 1994 ? (2) Was the peso undervalued or overvalued during the 1991-1994 period? Explain. Assume that the long-run average value of the real exchange rate index is 100 . (3) If inflation is higher in Mexico over time, compared to other countries, would you expect the real exchange rate index to trend upwards, trend downwards, or stay relatively flat over the course of a long time period (e.g. a century)?

Answer 1

The purchasing power of the peso decreased from 1991 to 1994 due to high inflation. The peso was undervalued during this period. If inflation is higher in Mexico compared to other countries over a long-time period, the real exchange rate index would trend downwards.

Step-by-step explanation:

The purchasing power of the peso decreased from 1991 to 1994. This is because Mexico experienced high inflation during this period, which eroded the value of the currency. As a result, the exchange rate value of the peso declined.

The peso was undervalued during the 1991-1994 period. The decrease in purchasing power and the decline in the exchange rate indicate that the peso was worth less compared to other currencies.

If inflation is higher in Mexico compared to other countries over a long-time period, the real exchange rate index would trend downwards. This is because high inflation would erode the purchasing power of the peso, making it less desirable for international investors to hold the currency.