The monetary approach to interest rates assumes that the prices of goods are ________, which implies that a country's currency will ________, when nominal interest rates ________ because of ________ expected future inflation.
A) perfectly flexible; depreciate; increase; higher
B) perfectly flexible; appreciate; increase; higher
C) immutable; depreciate; increase; higher
D) immutable; appreciate; decrease; higher
E) absolutely inflexible; depreciate; decrease; higher

Question

Quizplus · Accepted Answer

The monetary approach to interest rates assumes that the prices of goods are perfectly flexible, meaning that they can adjust quickly to changes in supply and demand. This implies that a country's currency will depreciate when nominal interest rates increase because of higher expected future inflation, as investors will demand a higher return to compensate for the anticipated loss in value of the currency due to inflation. Choice B is incorrect because an appreciation of the currency would be counterintuitive in this scenario, since higher expected future inflation would decrease the purchasing power of the currency. Choices C, D, and E are also incorrect due to their use of terms (immutable, appreciate, decrease, absolutely inflexible) that do not align with the assumptions of the monetary approach to interest rates.

The Monetary Approach to Interest Rates Assumes That the Prices