Question

An increase in which of the following factors (from the perspective of the domestic country) would cause a depreciation of the domestic currency in the short run?

Select one:

A. foreign interest rate

B. relative price level

C. relative export demand

D. all of the above

Answer 1

When the relative price level in a country increase, the value of the currency decreases as more is now needed to buy the same amount of good and services, thus the demand for the currency falls. The decline in the demand with same supply shifts the demand curve to the left thus depreciating the currency. (b)

Higher exports increase the demand for the local currency thus the appreciation. An increase in interest rates often spurs the inflation meaning that the inflation will be expected to increase in the foreign cu=ountry. Since the interest rates are not the mere reasons for increasing and decreasing the demand for currency, economic and political considerations are equally important. thus, the impact of foreign interest rate on domestic currency is ambiguous. However, in short run, it is not expected to change the domestic currency value much.