Assume sticky prices and given expectations of future exchange rates, what is the immediate effect on the exchange rate of the U.S. dollar if there is a temporary increase in the quantity of U.S. dollars?
A) U.S. nominal and real returns rates decline while euro rates hold steady, and the U.S. dollar depreciates against the euro.
B) U.S. nominal returns rise, U.S. real returns fall, euro rates rise, and the U.S. dollar appreciates against the euro.
C) U.S. nominal returns fall, U.S. real returns rise, euro rates fall, and the U.S. dollar appreciates against the euro.
D) U.S. dollar returns and euro returns both rise, leaving the exchange rate unchanged.

Question

Quizplus · Accepted Answer

A temporary increase in the quantity of U.S. dollars would lead to lower U.S. nominal and real return rates (due to the increased supply of money), while euro rates would remain unchanged if there's no change in the euro area's monetary policy. This would make holding euros relatively more attractive, leading to a depreciation of the U.S. dollar against the euro.

Assume Sticky Prices and Given Expectations of Future Exchange Rates