If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries.
A) spot; high
B) spot; low
C) forward; high
D) forward; low

Question

If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries.​
A) ​spot; high
B) ​spot; low
C) ​forward; high
D) ​forward; low

Quizplus · Accepted Answer

According to the international Fisher effect, currencies with high inflation rates should depreciate in the long run relative to low-inflation currencies. However, interest rate parity suggests that the forward rate should accurately predict the future spot rate, taking into account interest rate differentials between two currencies. Therefore, if both of these theories hold, the forward rate should be the more accurate forecast for currencies in high-inflation countries, as it incorporates the expected depreciation from the international Fisher effect.

If Both Interest Rate Parity and the International Fisher Effect