Question: Below is the regression input and output (from Excel) for the regression in which the percentage change in the exchange rate is the dependent variable (Y) and the inflation differential (inflation rate home – inflation rate foreign) is the independent variable (X). According to the Purchasing Power Parity theory, the hypothesized coefficients (null hypothesis) in the regression are 0 (intercept coefficient) and 1 (inflation differential coefficient). You will need to know how to test if a coefficient is different from 1; and how you calculate the t Statistic to test your null hypothesis from the Excel output. Excel will only directly provide a t statistic for the test of whether a coefficient is different from 0.

3a. Is there evidence to reject the null hypothesis that the intercept coefficient is equal to 0 at the 5% level of significance? (Hint: you will need a table with the t distribution to determine the critical t.)

3b. Is there evidence to reject the null hypothesis that the inflation differential coefficient (Inf h – Inf f) is equal to 1 at the 5% level of significance? (Hint: you will need a table with the t distribution to determine the critical t. You will not use the t Statistic given in the Excel output, because it corresponds to the null hypothesis that the inflation differential is equal to 0.)

3c. Overall, is there any evidence inconsistent with the Purchasing Power Parity theory? (Hint: The answer to this questions is yes, if you can reject at least one of the two above null hypotheses.)

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