If inflation in the United States averages more than inflation in the euro area over a long period of time, we should expect:
A) the dollar to appreciate relative to the euro.
B) the euro/U.S. dollar exchange rate to fluctuate in a narrow range set by the European Central Bank.
C) the dollar to depreciate relative to the euro.
D) no effect; there isn't a link between inflation and exchange rates over the long run.

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, a country that has a higher inflation rate will experience a decline in the value of its currency relative to another country with a lower inflation rate. Therefore, if inflation in the United States averages more than inflation in the euro area over a long period of time, we should expect the dollar to depreciate relative to the euro.

If Inflation in the United States Averages More Than Inflation