Question: 1. (PPP) "Some fast-growing poorer countries face a conflict between wanting to maintain a fixed exchange rate with a rich country and wanting to keep inflation low." Explain the logic behind this statement. Use the examples of Slovakia and China to illustrate your argument.
2. (UIP) What is a peso problem? In the case of fixed exchange rates, explain how peso problems can account for persistent interest rate differentials. Study the U.S.-Britain short-term (end-of-month) nominal interest rate differentials shown below for the year 1896 (from NBER series 13034). Both countries were on the gold standard at a fixed exchange rate of $4.86 throughout this year. Did the United States have a peso problem? When did it become really big? When did it go away? (Extra Credit: Do some research on the Web and discover the political reasons for the timing of this peso problem.)