When the Fed practices contractionary monetary policy, the interest rate _______ and the exchange rate _______ as a result.
A) rises; appreciates
B) rises; depreciates
C) falls; appreciates
D) falls; depreciates

Question

Quizplus · Accepted Answer

When the Fed practices contractionary monetary policy, it sells government securities, raises reserve requirements and increases the discount rate, which leads to a decrease in the money supply. With a decrease in money supply, the demand for borrowing increases, causing the interest rate to rise. Higher interest rates make domestic assets more attractive for foreign investors, resulting in an increase in demand for the domestic currency, causing it to appreciate. Therefore, when the Fed practices contractionary monetary policy, the interest rate rises, and the exchange rate appreciates as a result.

When the Fed Practices Contractionary Monetary Policy, the Interest Rate