Answer True or False. Briefly explain your answer. No credit without explanation

Question

Answer True or False. Briefly explain your answer. No credit without explanation. Support your answer with a graph if needed.

a )The Monetary Approach to the Exchange Rate Let’s analyze the nominal exchange rate between the Canadian dollar and the U.S. dollars in the long run. All else equal, an increase in the interest rate in Canada is associated, in the long run, with a lower real money demand and higher prices in Canada and an higher exchange rate in the long run.

b) From the PPP theory we can conclude that a country with higher inflation (relative to its foreign partners) should have an appreciating currency.

Explanation / Answer

a)Tr

Monetary approach to the exchange rate: uses monetary factors to predict how exchange rates adjust in the long run.A rise in the domestic interest rate,lowers domestic money demand,increasing the domestic price levelcausing a proportional depreciation of the domestic currency (through PPP).

b,)False

Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in order to return to PPP.

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