If over the next six months inflation is higher in the U.S.than in foreign countries,then according to purchasing-power parity
A)only the nominal exchange rate depreciates.
B)both the real and nominal exchange rate appreciate.
C)both the real and nominal exchange rate depreciate.
D)only the real exchange rate appreciates.

Question

Quizplus · Accepted Answer

According to purchasing-power parity, if inflation is higher in the U.S. than in foreign countries, the U.S. dollar should depreciate against foreign currencies to maintain parity. However, since only the nominal exchange rate includes the effect of inflation, it is the nominal exchange rate that would depreciate, while the real exchange rate would remain unchanged. Therefore, the correct answer is A, only the nominal exchange rate depreciates.

If Over the Next Six Months Inflation Is Higher in the U.S.than