Question

Suppose U.S. interest rates decline compared to the rest of the world. What would be the likely impact on the demand for dollars, supply of dollars, and exchange rate for dollars compared to, say, euros?

Answer 1

If the United States domestic interest declines as compared to the rest of the world then this would results in outflow of capital from U.S to the rest of the world. This is due to the reduction in the rate of return for the investors, lower rate of return force investors to withdrawn their funds from U.S.

This would reduced the demand for dollars and supply of dollar remains the same. The exchange rate for dollars also declines as compared to the other foreign currency, for example; euros.