Question

Explain with the aid of appropriate graphs the effect of the following on exchange rates in...

Explain with the aid of appropriate graphs the effect of the following on exchange rates in the short-run:

i. An increase in the domestic interest rate

ii. An increase in the foreign interest rate

iii. An increase in the expected future exchange rate

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Answer #1

An increase in domestic interest rates causes lower credit availability and hence exchanges rate appreciation takes place. Future exchanges rates increased anticipation is similar and causes exchange rate appreciation in long run.

Similarly increased in foreign interest rates causes investors to park more money outside and hence their currencies appreciate and domestic currency depreciates.

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