Inflation and the Foreign Exchange Market

Question

When nominal wages increase but real income declines due to high inflation, what is the expected effect on the country's forex market, as depicted in the graph?

Accepted Answer

The decline in real income is likely to reduce foreign investor confidence, shifting the demand curve for domestic currency to the left.

Answer

There would be no discernible effect on the foreign exchange market from changes in real income.

Answer

High inflation leads to a reduced supply of domestic currency, shifting the supply curve to the left.

Answer

An increase in nominal wages always strengthens the domestic currency, shifting the demand curve to the right.