A permanent increase in the domestic money supply
A) must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must rise proportionally.
B) must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must decrease proportionally.
C) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise proportionally.
D) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise more than proportionally.
E) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise less than proportionally.

Question

Quizplus · Accepted Answer

A permanent increase in the domestic money supply typically leads to inflation, which reduces the value of the domestic currency. This results in a proportional rise in the exchange rate (E), where E represents the price of foreign currency in terms of the domestic currency. Consequently, the expected future exchange rate must also rise proportionally, reflecting the anticipated continued effect of the increased money supply on the currency's value.

A Permanent Increase in the Domestic Money Supply