6. Inflation, interest rates, and exchange rates

Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies.

Consider the following statement:

Countries with lower inflation rates will have lower interest rates.

Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid.

The statement is valid, because the nominal interest rate is the sum of the real interest rate plus inflation, so lower inflation rates would result in lower interest rates.

The statement is invalid, because the nominal interest rate is independent of the inflation rate.

If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be by the losses from currency appreciation.

The currency of a country with a higher inflation rate than the U.S. inflation rate will over time against the dollar.