What is predicted to happen to the value of the dollar in the short run and...

What is predicted to happen to the value of the dollar in the short run and the long run if interest rates rise? How would this reflect in a graph?

Expert Solution

Answer: Increase in interest rates increases the value of dollar. The reason is followed from the demand and supply of currency in the foreign exchange market.

Short Run: Rise in interest rate > attracts foreign investors in domestic country as now they are getting higher return on their capital as compare to the less interest offering economies > hence demand for dollar exceeds supply of it in the forex market > as a result dollar gets appreciated just to clear the market in the short run.

Long Run: Appreciation in dollar value makes domestic products costly in the world market > as a result demand for domestic products get decresed in the world market > hence demand for dollar also get reduced in compare to supply of it. > Under the flexible exchange rate value of dollar starts depreciating to clear the forex market. So in the long run Value of dollar come to the natural value.

It can be shown by the graph below:

Rahul Sunny answered 2 years ago

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