When We Incorporate a Relationship Between Expected Inflation and Liquidity

Multiple Choice

When we incorporate a relationship between expected inflation and liquidity preference (demand for real balances) into our long-run model, which of the following occurs?

A) The exchange rate is unaffected.
B) The exchange rate rises in direct proportion to the increase in the quantity of money and the price level.
C) The exchange rate rises in direct proportion to the increase in the quantity of money, but inflation actually falls because of an increase in the demand for money.
D) The increase in interest rates and inflation after a change in the monetary growth rate affect exchange rates but also cause secondary effects on exchange rates and price levels because of a decrease in the demand for real balances.