Assume the interest parity condition holds and that initially i = i*. A decrease in the domestic interest rate will cause:
A) a decrease in the exchange rate.
B) an expected appreciation of the domestic currency.
C) a decrease in the demand for the domestic currency.
D) All of the above.
E) None of the above.

Question

Quizplus · Accepted Answer

Interest parity condition states that the expected return on domestic and foreign assets should be equal. A decrease in the domestic interest rate will make domestic assets less attractive, leading to a decrease in the demand for the domestic currency and an expected appreciation of the domestic currency. This will cause a decrease in the exchange rate (domestic currency becomes cheaper relative to foreign currency).

Assume the Interest Parity Condition Holds and That Initially I