What are the "deep" factors that change exchange rate expectations?
What will be an ideal response?
The "deep" factors that change exchange rate expectations are purchasing power parity and interest rate parity. Purchasing power parity is the proposition that money buys the same amount of goods and services in different currencies differences. If purchasing power parity does not prevail, in the long run the exchange rate changes so that it holds. People realize this change will occur and so it factors into their expectations of the exchange rate. Interest rate parity is the proposition that the interest rate in one currency equals the interest rate in another currency when exchange rate changes are taken into account. If interest rate parity does not prevail, the exchange rate changes immediately so that it holds. People realize that interest rate parity always prevails so it factors into their expectations of the exchange rate.
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If there is an excess supply of the domestic currency at a fixed exchange rate,
a. the currency will undergo a devaluation b. the currency will appreciate c. the country must switch to a floating exchange rate d. the central bank must buy up that excess supply or the exchange rate will fall e. the central bank must be up that excess supply or the exchange rate will rise
When there is an expansionary gap, inflation will ________, in response to which the Federal Reserve will ________ real interest rates, and output will ________.
A. decline; lower; expand B. increase; raise; decline C. decline; lower; decline D. decline; raise; decline