Assuming Sticky Prices and Given Expectations of Future Exchange Rates

question 6

Multiple Choice

Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of euros?

• A) Rates of return on domestic and foreign assets diverge, as the dollar appreciates.
• B) Domestic and foreign rates of return both fall, as the dollar depreciates.
• C) Domestic and foreign rates of return converge, as depreciation of the euro raises returns for U.S. investors who purchase euro-based assets.
• D) Rates of return on dollar assets fall, causing investors to switch into euro assets and, therefore, the U.S. dollar depreciates against the euro.

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