Question

A decrease in the domestic interest rate causes the demand for domestic currency to ________ and the domestic currency to ________, everything else held constant.

a) increase; depreciate
b) increase; appreciate
c) decrease; appreciate
d) decrease; depreciate

Answer 1

The correct answer is option d.

Step-by-step explanation:

A decrease in the domestic interest rates will make it less profitable for foreign residents to invest in domestic assets. This will decrease the demand for domestic currency.

The inflow of foreign capital will decrease. This decrease in demand will shift the demand curve to the left. As a result, the value of the domestic currency will decrease in the foreign market.

In other words, with a decrease in the demand for domestic currency, it will depreciate.