You read in a newspaper that the nominal interest rate is 12 percent per year in Canada and 8 percent per year in the United States. Suppose that the real interest rates are equalized in the two countries and that purchasing-power parity holds.

a) Using the Fisher equation, what can you infer about expected inflation in Canada and in the United States?
b) What can you infer about expected change in the exchange rate between the Canadian dollar and the U.S. dollar?
c) A friend proposes a get-rich-quick scheme: borrow from a US bank at 8%, deposit the money in a Canadian bank at 12%, and make a 4% profit. What is wrong with this scheme?

Refer to the diagram illustrating the market for corn. If the price in this market were to be fixed at $4 per bushel, the part of the line marked A would represent a:

a) To infer about the expected inflation in Canada and in the United States using the Fisher equation, we need to calculate the real interest rates in each country first. The Fisher equation states that the real interest rate is equal to the nominal interest rate minus the expected inflation rate.

Let's denote the nominal interest rate as r, and the expected inflation rate as π. The Fisher equation can be written as:

Real interest rate = Nominal interest rate - Expected inflation rate

In Canada:
Real interest rate in Canada = 12% - πc (where πc is the expected inflation rate in Canada)

In the United States:
Real interest rate in the US = 8% - πu (where πu is the expected inflation rate in the US)

Given that the real interest rates are equalized between the two countries, we can set these two equations equal to each other:

12% - πc = 8% - πu

We can rearrange this equation to solve for the expected inflation rates:

πc - πu = 12% - 8%
πc - πu = 4%

Therefore, we can infer that the expected inflation rate in Canada is 4% higher than the expected inflation rate in the United States.

b) Assuming purchasing-power parity holds, which means that the relative prices of goods and services should be the same in both countries, the exchange rate between the Canadian dollar and the U.S. dollar will change to reflect the relative changes in expected inflation rates.

Since the expected inflation rate in Canada is 4% higher than the expected inflation rate in the United States, we would expect the Canadian dollar to depreciate relative to the U.S. dollar. In other words, the exchange rate is expected to decrease.

c) The friend's proposed get-rich-quick scheme of borrowing from a US bank at 8%, depositing the money in a Canadian bank at 12%, and making a 4% profit seems like a simple and attractive way to benefit from the interest rate differential.

However, this scheme overlooks the fact that the expected inflation rates are different between the two countries. While the nominal interest rate differential is 4%, the expected inflation rate differential is also 4%. This means that the real interest rates in both countries are actually the same.

In other words, the higher nominal interest rate in Canada is compensating for the expected higher inflation rate, resulting in the same real interest rate as in the United States.

Therefore, there is no real profit to be made from this scheme. Any nominal gain from the interest rate differential will be offset by the corresponding difference in inflation rates and the depreciation of the Canadian dollar.