148
MACROECONOMICS
The relationship between the expected change in the real exchange rate, the
expected change in the nominal exchange rate, and the expected inflation can
then be written as
(
RER
e
)
_______
RER
=
E
e
____
E
+
*
e
-
e
The interest parity condition Eq. (5.8) states that
i
-
i
*
=
E
e
____
E
Substituting this into the previous identity we obtain
(
RER
e
)
_______
RER
=
i
-
i
*
+
*
e
-
e
,
or
i
-
i
*
=
(
RER
e
)
_______
RER
+
(
e
-
*
e
)
(5.17)
Hence, the domestic–foreign interest rate differential comprises two compo-
nents: (1) the expected ...
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