If the U.S. interest rate, adjusted for people's expectation of inflation, increases sharply relative to the rest of the world, then
A) there will be a decrease in the demand for dollars in foreign exchange markets.
B) there will be no change in the demand for dollars in foreign exchange markets but there will be an increase in demand for foreign currency.
C) the dollar will appreciate.
D) the dollar will depreciate.

Question

Quizplus · Accepted Answer

When the U.S. interest rate, adjusted for inflation expectations (real interest rate), increases sharply relative to the rest of the world, it makes holding assets denominated in dollars more attractive. This leads to an increase in demand for dollars as investors and savers worldwide seek to benefit from the higher returns. As demand for dollars increases, its value appreciates relative to other currencies.

If the US Interest Rate, Adjusted for People's Expectation of Inflation, Increases