Which of the following outcomes is most likely when an economy is experiencing sustained inflationary pressure?

Introduction / Context:
Inflation is a sustained rise in the general price level of goods and services in an economy. When an economy is under persistent inflationary pressure, it affects many macroeconomic variables such as exchange rates, interest rates, and the real value of financial assets. This question asks you to identify which listed outcome is most likely to occur when inflation is high and persistent, focusing particularly on the external value of the domestic currency and the fortunes of different economic agents.

Given Data / Assumptions:

• The economy is experiencing sustained inflation, not just a one time price spike.
• Other countries may have lower inflation rates by comparison.
• Exchange rates are at least partly market determined, so inflation differentials matter.
• We are considering typical textbook relationships, not rare or special cases.

Concept / Approach:
In international economics, when a country has a higher inflation rate than its trading partners, its goods become relatively expensive. This tends to reduce export competitiveness and may increase demand for imports, putting downward pressure on the domestic currency in foreign exchange markets. As a result, the domestic currency is likely to depreciate. At the same time, central banks often raise nominal interest rates to fight inflation, so the nominal cost of borrowing usually rises, not falls. Fixed interest bondholders typically lose in real terms because their interest payments have less purchasing power when prices are high.

Step-by-Step Solution:
Step 1: Recall that sustained inflation reduces the real purchasing power of the domestic currency. Step 2: Recognize that higher domestic prices relative to foreign prices tend to make exports less competitive and can encourage imports. Step 3: Understand that this relative price effect often leads to downward pressure on the domestic currency, causing depreciation in foreign exchange markets. Step 4: Compare the options and choose the one that correctly states that the domestic currency tends to depreciate under inflationary pressure.

Verification / Alternative check:
A simple way to check is to think of purchasing power parity ideas. If domestic prices are rising faster than foreign prices, the exchange rate usually adjusts so that the domestic currency can buy fewer foreign goods, which shows up as depreciation. This is consistent with option A and inconsistent with statements that suggest the domestic currency becomes stronger or that fixed interest asset holders gain in real terms.

Why Other Options Are Wrong:
Exports become more competitive and imports become cheaper: Under higher domestic inflation, exports generally become less competitive and imports often appear cheaper in real terms, so this statement reverses the usual relationship.
The cost of borrowing falls sharply: Central banks often raise nominal policy rates in response to inflation, so the nominal cost of borrowing usually increases rather than decreases.
Bondholders gain in real terms: Holders of fixed interest securities typically suffer because inflation erodes the real value of fixed coupon payments and principal.

Common Pitfalls:
Learners sometimes assume that inflation is automatically good for borrowers and bad for lenders without considering how interest rates adjust. They may also confuse nominal and real variables, forgetting that bondholders care about purchasing power, not just the money amount. Another mistake is to think that inflation strengthens a currency, when in fact persistent inflation relative to other countries usually leads to depreciation in the long run.

Final Answer:
When an economy is under sustained inflationary pressure, the most likely outcome is that the domestic currency tends to depreciate in foreign exchange markets.