Suppose interest parity holds.There is a change in U.S.policy that leads to expectations of a higher U.S.inflation rate.The increase in expected inflation will cause dollar interest rates to _______.

Question

Quizplus · Accepted Answer

According to interest parity, the interest rate differential between two countries equals the expected change in their exchange rate. If interest parity holds and there is an expectation of higher U.S. inflation, this will cause a decrease in the value of the dollar in the future, leading to a higher exchange rate in the present. To maintain interest parity, dollar interest rates will have to increase to compensate for the expected increase in exchange rate, making choice C the correct answer.

Suppose Interest Parity Holds