Holding all else constant,a decrease in the real interest rate on U.S.assets will _________ the supply of Canadian dollars in the foreign exchange market and _________ the equilibrium U.S.dollar-Canadian dollar exchange rate.

Question

Quizplus · Accepted Answer

A decrease in the real interest rate on U.S. assets would decrease the returns for investors holding U.S. assets, making them less attractive. This would reduce the demand for U.S. assets, including the demand for the U.S. dollar necessary to purchase those assets. This decrease in U.S. demand would, in turn, increase the supply of U.S. dollars on the foreign exchange market. Holding all else constant, the increased supply of U.S. dollars would cause the equilibrium U.S. dollar-Canadian dollar exchange rate to decrease. As a result, an decrease in the real interest rate on U.S. assets will decrease the demand for a currency, and thus, decrease the exchange rate.

Holding All Else Constant,a Decrease in the Real Interest Rate