Suppose the exchange rates between the United States and Canada are in long-run equilibrium as defined by the idea of purchasing power parity.If the law of one price holds perfectly,then differences between U.S.and Canadian rates of inflation would
A)have no effect on nominal exchange rates.
B)be completely offset by changes in the real exchange rate.
C)be completely offset by changes in the nominal exchange rate.
D)lead to a change in the real purchasing power of each country's currency when it is converted to the other country's currency.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) suggests that in the long run, exchange rates will adjust to offset changes in price levels between two countries. Therefore, differences in inflation rates between the U.S. and Canada would be offset by changes in the nominal exchange rate, keeping the real exchange rate relatively stable and preserving the purchasing power of each currency when converted.

Suppose the Exchange Rates Between the United States and Canada