An increase in the domestic one-year interest rate expected to occur in, say, tw

Q: An increase in the domestic one-year interest rate expected to occur in, say, tw

Option D Explanation: When the domestic interest rate is expected to increase, the demand for the domestic currency will increase relative to its supply as holding domestic currency would be more profitable now. So, the real, as well as the nominal exchange rate of the domestic currency, would increase.

ID: 1153010 • Letter: A

Question

An increase in the domestic one-year interest rate expected to occur in, say, two years will, all else fixed, have which of the following effects in a flexible exchange rate regime?

Select one:

a. The nominal exchange rate will increase with no change in the real exchange rate.

b. No change in either the nominal or real exchange rate.

c. The real exchange rate will increase with no change in the nominal exchange rate.

d. Both the real and the nominal exchange rate will increase.

e. The nominal exchange rate will increase and the real exchange rate will decrease.

Explanation / Answer

Option D

Explanation: When the domestic interest rate is expected to increase, the demand for the domestic currency will increase relative to its supply as holding domestic currency would be more profitable now. So, the real, as well as the nominal exchange rate of the domestic currency, would increase.

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An increase in the domestic one-year interest rate expected to occur in, say, tw

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