If the real interest rate is 5%,the rate of inflation in the United States is 6%,and the rate of inflation in the United Kingdom is 3%,which of the following statements would NOT be true?
A) The nominal rate of interest in the U.S. would be greater than the nominal interest rate in the U.K.
B) The difference between the U.K. and U.S. interest rates is a function of the difference between their inflation rates.
C) The nominal rate of interest in the United States and the United Kingdom would be the same because of purchasing power parity.
D) Investors would get a higher return on their money in the United States.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) refers to the idea that in the long run, exchange rates will adjust to equalize the prices of a similar basket of goods and services in different countries. In this case, because the inflation rate in the United States is higher than the inflation rate in the United Kingdom, the PPP would suggest that the nominal interest rate in the United States would be lower than the nominal interest rate in the United Kingdom. Thus, statement C is not true, as the nominal rate of interest in the United States would likely be lower than the nominal rate of interest in the United Kingdom.

If the Real Interest Rate Is 5%,the Rate of Inflation