To determine what happens to the Mexican real exchange rate under the given conditions, it's important to understand the difference between nominal and real exchange rates.
The real exchange rate (RER) adjusts the nominal exchange rate (NER) for differences in price levels between two countries. It can be expressed using the following formula:
\[ \text{Real Exchange Rate} = \left( \text{Nominal Exchange Rate} \times \frac{\text{Price Level in Domestic Country}}{\text{Price Level in Foreign Country}} \right) \]
In this case, we have:
- The nominal exchange rate does not change.
- Prices in Mexico are rising faster than in other countries.
As prices rise faster in Mexico, the price level in Mexico increases relative to the price level in other countries. Since the nominal exchange rate remains constant, this means that the real exchange rate will increase.
Thus, the correct answer is:
b. rises.
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