Question

Label each of the following statements true, false, or uncertain. Explain your choice carefully.

a. When domestic inflation equals foreign inflation, the real exchange rate is fixed.

b. A devaluation is an increase in the nominal exchange rate.

c. A sudden fear that a country is going to devalue leads to an increase in the domestic interest rate.

d. A change in the expected future exchange rate changes the current exchange rate.

e. Because economies tend to return to their natural level of output in the medium run, it makes no difference whether a country chooses a fixed or flexible exchange rate.

Answer 1

Answer:-
A-False
The increase in domestic inflation rate would cause the nominal exchange rate to depreciate, making imports of goods and services very expensive and exports very cheaper. This increases Imported inflation.
B-TRUE
a low domestic inflation rate relative to the foreign inflation rate
Justification:
Instance when the nominal exchange rate of the country decreases it will decrease the domestic inflation in relation to foreign. Hence, the fluctuation in the inflation will cause instable economy.
C-TRUE
A devaluation could cause higher economic growth .Part of AD is (X-M) therefore aggregate demand is high because of higher exports and lower imports higher aggregate demand or AD is likely to cause higher real GDP and inflation when inflation increases the domestic Interest rate would decrease hence the answer is True .
D-TRUE
It is true ,If the expected future exchange rate increases expected appreciation of the domestic currency rises.Since an appreciation of th domestic currency is good for the value of domestic assets,investors increase their demand for the domestic currecy resulting in increase in the actual exchange rate.
E-TRUE
a fix rate is a rate the government sets and maintain floating exchange rate is determined by the market supply and demand. here a floating currency allows a country to adjust to external shocks through the exchange rate but in fixed exchange domestic wages and prices will come under pressure instead floating exchange rates have a big drawback They can overshoot and becomes highly unstable especially if large amounts of capital flow in and out of a country hence it is false it does makes a difference in the choice of exchange rates.