Given an initial equilibrium in the money market and foreign exchange market, suppose the Federal Reserve decreases the money supply of the United States.Other things equal, under a floating exchange rate system, demand for the dollar will likely
A) increase, inducing an appreciation in value relative to other currencies.
B) decrease, inducing a depreciation in value relative to other currencies.
C) decrease, inducing an appreciation in value relative to other currencies.
D) increase, inducing a depreciation in value relative to other currencies.

Question

Quizplus · Accepted Answer

When the Federal Reserve decreases the money supply, interest rates in the United States tend to rise. Higher interest rates attract foreign capital, increasing the demand for dollars as investors exchange their currency for dollars to invest in the United States. This increased demand for dollars leads to an appreciation of the dollar relative to other currencies.

Given an Initial Equilibrium in the Money Market and Foreign