According the monetary approach, in the long run, a currency depreciates when the country's interest rate...

According the monetary approach, in the long run, a currency depreciates when the country's interest rate rises relative to another country's interest rate. Explain.

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Expert Solution

Answer:

When a country's interest rates rise, the currency of that country depreciates in the long run.

Let us understand this with the following steps:

1. When interest rate of a country increase, it becomes an attractive investment destination for the people outside. They start investing more and more money in our country to earn a better rate of interest.

2. Since lot of money starts pouring in, it leads to an increase in money supply

3. When money supply increases, it causes a situation of inflation in the long run.

4. Inflation in home country makes goods of the country expensive and unattractive.

5. As a result, people of home country start importing goods from outside.

6. More imports and less exports, lead to sale of home currency (to buy foreign currency and make payment for imports)

7. Supply of home currency increases and it depreciates in the long run.

I hope you like my explanation:)

Rahul Sunny answered 1 year ago

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