Assume that the interest parity condition holds and that both the expected exchange rate and foreign interest rate are constant.Given this information,a reduction in the domestic interest rate will cause
A)a reduction in the exchange rate expected in the future.
B)a reduction in the current exchange rate.
C)greater depreciation of the domestic currency expected in the future.
D)all of the above
E) none of the above

Question

Quizplus · Accepted Answer

According to the interest parity condition, a reduction in the domestic interest rate will cause a reduction in the expected future exchange rate to compensate for the lower return on domestic assets. However, since the expected exchange rate is constant, the only possible adjustment is a reduction in the current exchange rate. Therefore, choice B is correct. Choices A and C are incorrect because they imply a change in the expected future exchange rate, which is assumed to be constant in the question. Choice D is also incorrect because only one of the given options is correct.

Assume That the Interest Parity Condition Holds and That Both