If the law of one price holds for all goods and the quantity theory of money determines the long-run price level, we can pin down the long-run level of the exchange rate.

Question

Quizplus · Accepted Answer

If the law of one price holds for all goods, then identical goods should have the same price in different countries, and if the quantity theory of money is true, then in the long run, the price level is determined by the money supply. Since the exchange rate is the relative price of two currencies, and the prices of goods determine the price level, we can derive the long-run level of the exchange rate. Therefore, the statement is true.

If the Law of One Price Holds for All Goods