1. clearly reflect movements in the equilibrium real exchange rate if they extend over several years.
2. can reflect overshooting monetary shocks over periods of a few months.
3. are not likely to be dependent over the long run upon differences between domestic and foreign inflation.
4. are consistent with all of the above statements.
Choose the correct option.
The right option is 4. The immediate effect of an unanticipated money shock will be an overshooting adjustment of the nominal and real exchange rates. This could reasonably last for a few months. Ultimately, of course, the price level will adjust and the real exchange rate will return to its equilibrium level, which would most likely not have been affected by the money shock. Since price adjustment is likely to be complete after two or three years, it is unlikely that money shocks could account for major movements in real exchange rates extending over several years. These movements have to be the result of underlying changes in the equilibrium real exchange rate due to shifts in the relative supply and world demand for domestic relative to foreign goods.