Assume the interest parity condition holds and that initially i = i*.A reduction in the domestic interest rate will cause
A)an increase in the demand for the domestic currency.
B)a reduction in E.
C)an expected depreciation of the domestic currency.
D)all of the above

Question

Quizplus · Accepted Answer

According to the interest parity condition, a reduction in domestic interest rate will decrease the return on domestic assets relative to foreign assets, causing investors to buy less of domestic assets and more of foreign assets, leading to an increase in the demand for the foreign currency, and, therefore, a depreciation of the domestic currency. This is consistent with choices A, B, and C, implying that all of the above are correct.

Assume the Interest Parity Condition Holds and That Initially I