In the long run, the nominal exchange rate

Question

Quizplus · Accepted Answer

The nominal exchange rate is the rate at which one currency can be exchanged for another. It is determined by the supply and demand for each currency, which is influenced by various factors including trade flows, capital flows, and expectations about future exchange rates. However, in the long run, the nominal exchange rate is primarily a monetary phenomenon, as it is determined by the quantities of money in two countries. Specifically, if the money supply in one country increases relative to the other country, this should lead to an increase in the nominal exchange rate (i.e., the currency of the country with the higher money supply should depreciate relative to the other currency). This is because an increase in the money supply leads to higher prices in that country, which reduces the purchasing power of its currency, and thus makes it less valuable relative to other currencies. Therefore, choice B is the best answer. Choices A, C, and D are all incorrect because they either make incorrect statements or are not relevant to the question.

In the Long Run, the Nominal Exchange Rate