Suppose inflation is higher in Canada over the next few months than in foreign countries, and exchange rates are given in terms of how much foreign currency a dollar buys or how many foreign goods Canadian goods buy. According to purchasing-power parity, which of the following should we expect to see?
A)Only the nominal exchange rate depreciates.
B)Both the real and nominal exchange rates appreciate.
C)Both the real and nominal exchange rates depreciate.
D)Only the real exchange rate appreciates.

Question

Quizplus · Accepted Answer

According to purchasing-power parity, if inflation is higher in Canada than in foreign countries, the Canadian dollar should depreciate in value relative to foreign currencies. This means that the nominal exchange rate (the number of foreign currency units per Canadian dollar) should decrease. The real exchange rate (the price of Canadian goods and services relative to foreign goods and services) should also decrease, as Canadian goods and services will become more expensive relative to foreign goods and services.

Suppose Inflation Is Higher in Canada Over the Next Few