The relationship between nominal exchange rate and relative prices. From the annual observations from 1980 to 1994, the following regression results were obtained, where Y = exchange rate of the German mark to the U.S. dollar (GM/$) and X = ratio of the U.S. consumer price index to the German consumer price index; that is, X represents the relative prices in the two countries:
Yˆt = 6.682 - 4.318 Xt r 2 = 0.528 se = (1.22)(1.333)
a. Interpret this regression. How would you interpret r 2 ?
b. Does the negative value of Xt make economic sense? What is the un- derlying economic theory?
c. Suppose we were to rede?ne X as the ratio of German CPI to the U.S. CPI. Would that change the sign of X? And why?