Why would lowering its own interest rates affect a nation's exchange rate?
A) International interest arbitrage (the ability to borrow in low-rate markets and deposit in higher-rate markets) would cause investors to sell domestic currency assets and purchase foreign assets based in other currencies.
B) A nation's central bank controls both interest rates and exchange rates. Unfortunately, they do not have sufficient funds to take care of both at the same time.
C) When interest rates fall, borrowing is cheaper, spending and GDP rise and so do exports, thus causing the exchange rate to appreciate.
D) In the short run, exchange rates have to adhere to PPP; otherwise, traders will make profits by purchasing in the cheap market and selling in the more expensive market, thus aligning exchange rates at the proper level.

Question

Quizplus · Accepted Answer

Lowering interest rates in a nation would make its currency less attractive to foreign investors, as they would receive lower returns on their investments. This would lead to a decrease in the demand for the nation's currency, causing its exchange rate to decrease. Additionally, international interest arbitrage would create a situation where investors sell domestic currency assets and purchase foreign assets based in other currencies, further decreasing demand for the nation's currency and lowering its exchange rate.

Why Would Lowering Its Own Interest Rates Affect a Nation's