Question

Label each of the following statements true, false, or uncertain. Explain your choice carefully.

a. When domestic inflation equals foreign inflation, the real exchange rate is fixed.

b. A devaluation is an increase in ? when the nominal exchange rate ? is defined as the price of the domestic currency in terms of foreign currency.

c. A change in the expected future exchange rate changes the current exchange rate.

d. Because economies tend to return to their natural level of output in the medium run, it makes no difference whether a country chooses a fixed or flexible exchange rate.

Answer 1

a) False,

when domestic inflation = foreign inflation , real exchange rate is not fixed as fixed exchange rate means that exchange rate will not move when inflation changes

b ) true

Depreciation , increase in nominal exchange rate means that the price of foreign currency has increased in terms of domestic currency i.e domestic currency has become weak relative to foreign currency .

c ) True

changes in expectation about the future exchange rate will effect current exchange rate as demand and supply of currencies will be affected causing the current rate to change .

d) False

the statement is false , as fixed or flexible exchange rate affects the growth rate by affecting the deficits / surplus