Suppose interest rates fall sharply in Canada but are unchanged in Great Britain.Ceteris paribus,under a system of flexible exchange rates,we can expect the British demand for Canadian dollars to:
A)increase, the supply of Canadian dollars for pounds to decrease, and the dollar to appreciate vis-a-vis the pound
B)decrease, the supply of Canadian dollars for pounds to decrease, and the dollar to either appreciate or depreciate vis-a-vis the pound
C)decrease, the supply of Canadian dollars for pounds to increase, and the dollar to depreciate vis-a-vis the pound
D)increase, the supply of Canadian dollars for pounds to decrease, and the dollar to depreciate vis-a-vis the pound
E)increase, the supply of Canadian dollars for pounds to decrease, and a Canadian balance of payments surplus to develop

Question

Quizplus · Accepted Answer

When interest rates fall in Canada but remain unchanged in Great Britain, investments in Canada become less attractive compared to those in Great Britain. This leads to a decrease in the British demand for Canadian dollars (as fewer investors or savers are looking to hold Canadian assets). Simultaneously, Canadians might seek higher returns in Great Britain, increasing the supply of Canadian dollars for pounds. The increased supply of Canadian dollars and decreased demand for them lead to the Canadian dollar depreciating vis-a-vis the pound.

Suppose Interest Rates Fall Sharply in Canada but Are Unchanged