If the U.S. interest rate differential increases, then in the foreign exchange market the
A) supply of U.S. dollars increases.
B) demand for U.S. dollars does not change.
C) quantity of U.S. dollars supplied increases.
D) supply of U.S. dollars decreases.

Question

Quizplus · Accepted Answer

An increase in the U.S. interest rate differential will make U.S. financial assets more attractive to foreigners, increasing the demand for dollars. However, this will also lead to an increase in the supply of dollars as U.S. investors buy more foreign assets with their stronger currency. The net effect will be an increase in the supply of dollars and a decrease in their value, which is represented by choice D.

If the US Interest Rate Differential Increases, Then in the Foreign Exchange