Question : An increase in the nominal exchange rate can be caused by:
Option 1: Lower interest rates in the domestic economy.
Option 2: Higher inflation rates in the domestic economy.
Option 3: Lower inflation rates in the domestic economy.
Option 4: Government intervention in the foreign exchange market.
Correct Answer:
Higher inflation rates in the domestic economy.
Solution : The correct answer is (b) Higher inflation rates in the domestic economy.
When a country experiences higher inflation rates compared to its trading partners, it erodes the purchasing power of its currency. This can lead to a decrease in the value of the domestic currency relative to other currencies, resulting in an increase in the nominal exchange rate.
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