Answer True or False. Briey explain your answer. No credit without explanation.

Question

Answer True or False. Briey explain your answer. No credit without explanation. Support your answer with a graph if needed.

a The Monetary Approach to the Exchange Rate Let’s analyze the nominal exchange rate between the Canadian dollar and the U.S. dollars in the long run. All else equal, an increase in the interest rate in Canada is associated, in the long run, with a lower real money demand and higher prices in Canada and an higher exchange rate in the long run.

b From the PPP theory we can conclude that a country with higher ination (rel- ative to its foreign partners) should have an appreciating currency.

Explanation / Answer

a. True. When the interest rate in foreign country is higher than the interest rate in domestic country, the foreign currency has to depreciate by i* - i in the long run.

b. False. The country with a higher inflation will have a depreciating currency.

Exchange Rate = Price level in the home country / Price level in the foreign country

Thus, rise in the price level will lead to depreciating currency.

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