If the U.S.inflation rate rises to the foreign inflation rate, then in the foreign exchange market
A) the demand for dollars increases, and the supply of dollars increases.
B) the demand for dollars increases, and the supply of dollars decreases.
C) the demand for dollars decreases, and the supply of dollars increases.
D) the demand for dollars decreases, and the supply of dollars decreases.

Question

Quizplus · Accepted Answer

If the U.S. inflation rate rises to the foreign inflation rate, then the purchasing power of the dollar decreases relative to the foreign currency. This makes U.S. exports less competitive and foreign imports more expensive, resulting in a decrease in U.S. demand for foreign currency and an increase in the supply of dollars. Conversely, foreigners will have an increased demand for dollars as imports from the U.S. become cheaper. This will result in a decrease in the foreign currency's demand and an increase in foreign currency's supply. Therefore, the correct answer is C - the demand for dollars decreases, and the supply of dollars increases.

If the USinflation Rate Rises to the Foreign Inflation Rate, Then in Then