Economics: Case Study
Question 1
Purchasing Power Parity (PPP) is an economic theory that is used to measure different prices of countries using goods and services. PPP implies that the countries’ two currencies are at equilibrium if the costs of products are priced the same after their considering the exchange rates (McKinnon and Ohno 42-43). An informal way of explaining the PPP includes using the Big Mac index. This concept uses the price of the Big Mac Burger in a specific country as a tool to compare with the amount of Big Mac in the other country. The Big Mac index calculation is no longer having the same effect since it deems currencies with a higher index to be priced while those with lower indexes to be under-priced.
Question 2
According to FRED codes, the United States (US) and Canada were last at their exchange rate parity on 6 April 2010. The US has historically maintained a stronger national currency than the Canadian dollar. When the 2008 financial crisis affected the US economy, Canada was able to catch up with the USA and increased exports. In 2010, the US started recovering, which meant that as the US dollar gained value, and it came close to the Canadian dollar until it reached a state of equilibrium. Hence this implies that parity resulted from the temporary effect of the recession on the US. The recession meant the US relied on more imports from Canada, which meant the demand for the Canadian dollar increased. However, this changed when the US economy recovered, and everything was back to equilibrium.
Question 3
The National Bank of Belgium was one of the first financial institutions to engage in the reduction of its US dollar reserves. The Federal Reserves’ response to that event was to inject more cash into the economy. Having more money in the economy led to inflation, thus crippling the economy in the process. The interest rates increased, and some banks on Wall Street collapsed, leaving many Americans in debt. The PPP of US consumers in that period declined. The actions of the Federal Reserve played a significant role in collapsing the US economy. Hence the increased currency injection into the economy was a factor in the collapse of the US economy.