Expectations Theory of Exchange Rates

Very Easy Currency Exchange Rates Exchange Rate Models

In the context of currency exchange rate models, the expectations theory suggests that exchange rates will adjust to reflect market participants' expectations of future exchange rate movements. This theory plays a crucial role in understanding how currencies price in relation to one another.

Which of the following statements best exemplifies the expectations theory of exchange rates?

Exchange rates are determined solely by the current interest rates in the economy.

Exchange rates will move in anticipation of future changes in interest rates or inflation rates.

Current exchange rates are fixed and do not respond to economic fundamentals.

Hint

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