If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries.
A) spot; high
B) spot; low
C) forward; high
D) forward; low

Question

Quizplus · Accepted Answer

The international Fisher effect suggests that currencies of countries with higher inflation rates should depreciate relative to currencies of countries with lower inflation rates. Meanwhile, interest rate parity suggests that the forward rate should be an unbiased predictor of future spot rates. Therefore, the forward rate should be adjusted for interest rate differentials, giving more accurate forecasts for currencies of high-inflation countries.

If Both Interest Rate Parity and the International Fisher Effect