When exchange rates are fixed and the foreign nation's interest rate increases, what happens next?
A) The home nation's IS curve shifts out because of a depreciation and an increase in the trade balance.
B) The home nation's LM curve shifts right, and its interest rate falls.
C) Fixed exchange rates force the home nation to raise its interest rates.
D) The home nation and the foreign nation are always in equilibrium, so no changes occur.

Question

Quizplus · Accepted Answer

When exchange rates are fixed and the foreign nation's interest rate increases, there will be a capital outflow from the home nation to the foreign nation seeking higher returns. This will force the home nation to raise its interest rates to maintain the fixed exchange rate.

When Exchange Rates Are Fixed and the Foreign Nation's Interest