Question

Assume that the one-year interest rate in the United States is 7 percent and in the United Kingdom is 5 percent. According to the international Fisher effect, the British pound's spot exchange rate should ______ by about______ over the year.

a) Appreciate; 2%
b) Depreciate; 2%
c) Appreciate; 7%
d) Depreciate; 7%

Answer 1

According to the international Fisher effect, the British pound's exchange rate should depreciate based on the difference in interest rates between the US and the UK. In this case, it should depreciate by about 2% over the year. The correct answer is b).

Step-by-step explanation:

According to the international Fisher effect, the British pound's exchange rate should appreciate or depreciate based on the difference in interest rates between the United States and the United Kingdom. In this case, since the interest rate in the United States is higher than in the United Kingdom, the British pound should depreciate.

The formula for the international Fisher effect is: % change in exchange rate ≈ (Interest rate in the United States - Interest rate in the United Kingdom).

Therefore, based on the given interest rates, the British pound should depreciate by about 2% over the year. Hence, option (b) is correct: Depreciate; 2%.