Suppose that on April 1, 2015, the central bank of India contracted that country

Question

Suppose that on April 1, 2015, the central bank of India contracted that country's money supply by selling bonds and increasing interest rates. Which of the answer choices gives the most likely outcome of the U.S. dollar and Indian rupee after April 1, 2015? Note: Assume that the U.S. Federal Reserve does not alter its monetary policy in response to the actions by India's central bank.

A. The U.S. dollar depreciates against the Indian rupee, and Indian imports from the U.S. increase

B. The U.S. dollar depreciates against the Indian rupee, and Indian imports from the U.S. decrease.

C. The U.S. dollar appreciates against the Indian rupee, and Indian exports to the U.S. increase.

D. The U.S. dollar appreciates against the Indian rupee, and Indian exports to the U.S. decrease.

Explanation / Answer

The answer to this question is B. When the interest rates are increased, price levels also rise. Because of this the currency depreciates, which means that imports become more expensive and hence Imports from US will go down.

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