According to the doctrine of purchasing-power parity,which of the following should depreciate if over the next year the inflation rate is higher in the U.S.than in the Euro area?
A)both the U.S.real exchange rate and the U.S.nominal exchange rate
B)the U.S.real exchange rate,but not the U.S.nominal exchange rate
C)the U.S.nominal exchange rate,but not the U.S.real exchange rate
D)neither the U.S.nominal exchange rate nor the U.S.real exchange rate

Question

Quizplus · Accepted Answer

According to the doctrine of purchasing-power parity, if the inflation rate is higher in the U.S. than in the Euro area, then the U.S. dollar should depreciate. This will cause a decrease in the U.S. real exchange rate, which is the ratio of the prices of a basket of goods between the two countries. However, the nominal exchange rate, which is the price of one currency in terms of another, may not necessarily depreciate due to other factors such as changes in interest rates or capital flows. Therefore, option C, which states that only the U.S. nominal exchange rate will depreciate, is the best choice.

According to the Doctrine of Purchasing-Power Parity,which of the Following