Consider the exchange rate between Lebanon and Canada. Typically, exchange rates vary over time, sometimes quite dramatically. The scenarios present various changes that may affect the exchange rate. Identify whether each scenario will tend to cause an appreciation, depreciation, or have no effect on the exchange rate of Lebanese pounds relative to Canadian dollars. The magazine The Economist publishes an article indicating that analysts expect the value of Canadian dollars to rise relative to Lebanese pounds. The central bank in Lebanon announces that it is going to raise interest rates on government bonds. Based on a World Bank report, the inflation rate in Lebanon is going to be 5% next year, whereas the inflation rate in Canada is going to be 9.5% . The price of a specific basket of goods in Lebanon is roughly 1.3 times higher than the price of an identical basket of goods in Canada even after adjusting for the exchange rate.

Answer and Explanation:

1. The magazine The Economist publishes an article indicating that analysts expect the value of Canadian dollars to rise relative to Lebanese pounds: if the expectation from analysts is that the value of Canadian dollars will rise relative to Lebanese pounds then the demand for Canadiam dollars will increase therefore increasing the value/appreciate relative to Lebanese pounds.

2. The central bank in Lebanon announces that it is going to raise interest rates on government bonds: This will bring about appreciation in Lebanese pounds relative to Canadian dollars since increase in interest rate in bonds increases investment in government bonds in Lebanese pounds.

3. Based on a World Bank report, the inflation rate in Lebanon is going to be 5% next year, whereas the inflation rate in Canada is going to be 9.5%: A high inflation rate is a negative for the economy. Since inflation rate increases for both economies, there is likely to be a counter effect hence no effect on exchange rates.

4. The price of a specific basket of goods in Lebanon is roughly 1.3 times higher than the price of an identical basket of goods in Canada even after adjusting for the exchange rate: if this basket of goods is used in calculation of consumer price index(CPI) which is representative of the rate of inflation in the economy, then Lebanese pounds will depreciate relative to Canadian dollars since inflation rate has increased relative to the Canadian economy.

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