Which statement best describes the effects of an increase in the price level?
A) Real exchange rates and interest rates rise.
B) Real exchange rates and interest rates fall.
C) Real exchange rates fall, and interest rates rise.
D) Real exchange rates rise, and interest rates fall.

Question

Quizplus · Accepted Answer

When the price level increases, the currency becomes relatively less valuable and foreign imports become relatively cheaper, which leads to an increase in demand for foreign currency and a decrease in demand for domestic currency, resulting in a depreciation of the real exchange rate. This also leads to an increase in domestic interest rates as investors demand higher rates to hold the now relatively less valuable domestic currency.

Which Statement Best Describes the Effects of an Increase in the Price