The Argentine peso was fixed through a currency board at Ps1.00/$ throughout the 1990s. In January 2002 the Argentine peso was floated. On January 29, 2003 it was trading at Ps3.20/$. During that one year period Argentina's inflation rate was 20% on an annualized basis. Inflation in the United States during that same period was 2.2% annualized. Required:
a. What should have been the exchange rate in January 2003 if PPP held?
b. By what percentage was the Argentine peso undervalued on an annualized basis?
c. What were the probable causes of undervaluation?

1. 1.17416 peso/$

2. -63.30%

Explanation:

1. The exchange rate in January if PPP is held

1.00 = exchange rate

20 % = inflation in Argentina

0.22% = us inflation

1.00(1+0.20)/(1+0.022)

= 1.00x1.20/1.022

= 1.17416 pesos/$

B. Percentage by which pesos was devalued

(PPP/actual exchange rate)-1

= 1.17416/3.20 -1

= 0.366925-1

= -0.6330

= -63.30%

C. At 20 % we can see that inflation is really high in Argentina which is probably the reason for the undervaluation. But the truth is inflation alone cannot be held responsible. Severe crisis in Argentinas balance of payment is partly responsible

answer; the above statement/question is ( true);