During the period 2001-04, the U.S. Federal Reserve lowered nominal interest rates on the dollar by more than the European Central Bank (ECB) did on the euro, a move that most market participants viewed as temporary. What was the effect on the dollar-euro exchange rate?
A) The dollar depreciated against the euro.
B) The dollar appreciated against the euro.
C) There was no change in the dollar-euro rate because expectations adjusted.
D) There was no change in the dollar-euro rate because real interest rates were unchanged.

Question

Quizplus · Accepted Answer

When nominal interest rates are lowered, the currency of that country tends to depreciate relative to other currencies. This is because lower interest rates reduce the return on holding that currency, making it less attractive to investors. In this case, the U.S. Federal Reserve lowered nominal interest rates more than the ECB, causing the dollar to depreciate relative to the euro.

During the Period 2001-04, the U