True or False?
The correct answer is False. The purchasing-power-parity theory says that the full-employment equilibrium real exchange rate is a constant. It does not say that the real exchange rate is constant in the short-run when money shocks have not yet had time to work their effects on output and prices. An unanticipated money expansion will cause an immediate devaluation of the nominal and real exchange rates sufficient to maintain asset equilibrium. This devaluation of the nominal exchange rate will be in excess of the amount ultimately required to reestablish long-run equilibrium. And the devaluation of the real exchange rate will be reversed as soon as the price level has risen to reduce the real money stock to its original, and equilibrium, level.