Answer to Question #219911 in Macroeconomics for Collins

Question

1.Write down and explain the uncovered interest parity (UIP) condition.
(a) What does it imply about the relationship between domestic and foreign interest
rates?
(b) Suppose that you expect the Ghana cedi to appreciate relative to the US dollar,which
bond should you buy? What happensto the domestic (i.e., Ghana) interest rate relative
to the US? Explain.
2. Estimate the Okun’s law and Philips’s curve equations for Ghana over two periods
(1983-2000 and 2001-2018. Explain fully the difference in the estimates of the two
periods for both equations. [Hint: Use the average annual GDP growth rate for each
period as the normal growth rate for the Okun’s law equations and use the period average
unemployment rate as the natural rate of unemployment for the Philips curve equation.

Answer 1

1.The uncovered interest parity condition states that the difference in interest rates between two countries will be equal to the relative change in currency foreign exchange rates over the same period. If the uncovered interest rate parity does not hold, then there is an opportunity to make a risk free profit.

(a)

the uncovered interest parity controls the relationship between foreign and domestic interest rates and currency exchange rates. It assumes foreign exchange equilibrium, thus implying that the expected return of a domestic asset will be same as the expected return of a foreign asset after adjusting the change in spot rates of foreign currency exchange .

(b)

You should buy a US bond because it will have a risk free money market. It will trade at a forward premium against the Ghanian cedi.

The domestic interest rate of Ghana will appreciate relative to the domestic interest rate of US . This is because the US will be trading at a forward premium relative to Ghana while Ghana will be trading at a forward discount relative to the US.

2.

Okun's law

According to Okun, a country's GDP will rise if the country experiences a percentage increase in employment.

Within the two periods given, Ghana's total employment raised from 5.4 million to 10.2 million when the annual growth rate improved from 2.5% to 5.2%. When looking at Ghana, the unemployment spell of an individual is determined by the reservation wage, marital status, education and age.

Phillips curve

Phillips curve model has been employed in the empirical establishment of inflation and unemployment in Ghana. According to this model, the desired price of firms that would maximize profit at a particular point in time is specified as follows:

$P_t*=P_t -(y_t-y_e)$

This explains that the desired price of a firm $P_t*$ is affected by the general price level and the unemployment derivation from its natural rate shown by the cyclical gap $(y_t-y_e)$. This implies that a firm's desired relative price rises during economic boom and falls when an economy experiences recession.