A fall in the domestic interest rate leads to capital outflows, which make the exchange rate depreciate.The monetary expansion of the mid-1990s was expected to lead to a currency appreciation.

Question

Quizplus · Accepted Answer

A fall in domestic interest rates makes domestic assets less attractive to investors, leading to capital outflows as investors seek higher returns elsewhere. This increases the supply of the domestic currency in the foreign exchange market, leading to depreciation. Conversely, monetary expansion, by lowering interest rates, would typically lead to depreciation, not appreciation, contradicting the expectation mentioned for the mid-1990s scenario.

A Fall in the Domestic Interest Rate Leads to Capital