The nominal interest rate is 12 percent per year in Canada and 8 percent per year in the United States. Suppose that the real interest rates are equalized in the two countries and that purchasing-power parity holds.

What can you infer about expected change in the exchange rate between the Canadian dollar and the U.S. dollar?

To determine the expected change in the exchange rate between the Canadian dollar (CAD) and the U.S. dollar (USD), we need to analyze the given information about nominal interest rates, real interest rates, and purchasing-power parity.

1. Nominal Interest Rates: The nominal interest rate in Canada is 12% per year, while in the United States, it is 8% per year. These rates represent the interest rates charged on loans before accounting for inflation.

2. Real Interest Rates: Real interest rates account for inflation and provide a more accurate measure of the true cost of borrowing. The question states that the real interest rates are equalized in both countries. It means that after adjusting for inflation, the real interest rates in Canada and the United States are the same.

3. Purchasing-Power Parity (PPP): Purchasing-power parity is an economic theory that states that the exchange rate between two currencies should reflect their relative purchasing power. In other words, the exchange rate should adjust to equalize the cost of a basket of goods in different countries.

Based on the given information, we can infer the following:

- Since the real interest rates are equalized in both countries, it implies that the inflation rates in Canada and the United States are expected to be equal as well.
- The nominal interest rates in Canada (12%) are higher than in the United States (8%), indicating that the market expects higher inflation in Canada compared to the United States.
- According to purchasing-power parity, if inflation is expected to be higher in Canada than in the United States, the exchange rate between the two currencies should adjust to offset the difference.
- Therefore, we can infer that the market expects the Canadian dollar (CAD) to depreciate, and the U.S. dollar (USD) to appreciate relative to the exchange rate between the two currencies.

In conclusion, based on the given information about nominal interest rates, real interest rates, and purchasing-power parity, we can infer that the expected change in the exchange rate between the Canadian dollar and the U.S. dollar is a depreciation of the Canadian dollar and an appreciation of the U.S. dollar.