All else equal, an increase in the base country's interest rate should cause a(n) ____ in the interest rate of a country that fixes its exchange rate to the base country.
A) decline
B) negligible impact
C) increase
D) change in the exchange rate regime

Question

Quizplus · Accepted Answer

If the base country increases its interest rate, investors will be attracted to invest in it, causing an increase in demand for its currency. This will lead to an appreciation of the base country's currency and thus an increase in the exchange rate for the fixed exchange rate country. In order to maintain the fixed exchange rate, the fixed exchange rate country's central bank will have to increase its interest rate as well. Therefore, an increase in the base country's interest rate should cause an increase in the interest rate of a country that fixes its exchange rate to the base country.

All Else Equal, an Increase in the Base Country's Interest