When the Fed practices contractionary monetary policy, the interest rate goes:
A) up, and the exchange rate will appreciate as a result.
B) up, and the exchange rate will depreciate as a result.
C) down, and the exchange rate will appreciate as a result.
D) down, and the exchange rate will depreciate as a result.

Question

Quizplus · Accepted Answer

When the Fed practices contractionary monetary policy, it reduces the money supply in the economy, which leads to an increase in the interest rate. This makes domestic investments more attractive, leading to an influx of foreign investment, which increases the demand for domestic currency and causes it to appreciate. Therefore, the exchange rate will appreciate as a result of the increase in interest rates.

When the Fed Practices Contractionary Monetary Policy, the Interest Rate