If Europe has a real GDP growth rate of 5%, and the United States has a real GDP growth rate of 6%, while money growth in Europe is 7%, and money growth in the United States is 5%, what would the monetary exchange rate model predict for exchange rates in the long run?
A) The U.S. dollar would appreciate by 3% against the euro.
B) The U.S. dollar would depreciate by 3% against the euro.
C) The U.S. dollar and the euro would not change against each other because the growth rates are offsetting.
D) The U.S. dollar would appreciate by 1% against the euro.

Question

Quizplus · Accepted Answer

The monetary exchange rate model suggests that the currency of a country with lower money growth relative to its GDP growth will appreciate. The U.S. has a lower money growth rate (5%) compared to its GDP growth (6%), while Europe has a higher money growth rate (7%) compared to its GDP growth (5%). This implies the U.S. dollar would appreciate against the euro. The difference in money growth rates (7% - 5% = 2%) minus the difference in GDP growth rates (6% - 5% = 1%) results in a 3% appreciation of the U.S. dollar against the euro.

If Europe Has a Real GDP Growth Rate of 5