Ch 17:

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.

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

A: 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.

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

2: If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be (CHOOSE ONE: OFFSET or MULTIPLIED) by the losses from currency appreciation.

3: The currency of a country with a higher inflation rate than the U.S. inflation rate will (CHOOSE ONE: DEPRECIATE or APPRECIATE) over time against the dollar.