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

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According to interest parity, the interest rate differential between two countries' currencies is equal to the difference between the expected exchange rate change and the forward exchange rate. If there is an increase in expected inflation in the U.S., the interest rate in the U.S. will likely rise to compensate for the increased inflation. This will cause dollar interest rates to rise.

Suppose Interest Parity Holds