Using the relationship between expected exchange rates and inflation differentials in combination with uncovered interest parity, we find:
A) changes in inflation rates are directly related to changes in nominal interest rates.
B) changes in inflation rates are inversely related to changes in nominal interest rates.
C) changes in inflation rates are unrelated to changes in nominal interest rates.
D) changes in inflation rates are directly related to changes in real interest rates.

Question

Quizplus · Accepted Answer

The relationship between expected exchange rates and inflation differentials, in combination with uncovered interest parity, suggests that changes in inflation rates are directly related to changes in nominal interest rates. This is because higher inflation typically leads to higher nominal interest rates as lenders demand higher returns to compensate for the decreased purchasing power of money.

Using the Relationship Between Expected Exchange Rates and Inflation Differentials