Question

Which one of the following will tend to cause domestic interest rates to rise?

1) an increase in the money supply
2) a decrease in the rate of inflation
3) a decrease in the federal budget deficit
4) an increase in interest rates overseas

Answer 1

Domestic interest rates are most likely to rise due to an increase in interest rates overseas, as investments shift in search of higher returns. A domestic budget deficit can also cause interest rates to rise due to increased government borrowing.

Step-by-step explanation:

Among the options given, domestic interest rates are most likely to rise due to an increase in interest rates overseas. When rates are higher overseas, investors will typically seek the higher returns available there, which in turn means that domestic rates usually need to rise to attract investment back.

This is also influenced by an increase in the demand for foreign currency, driving appreciation of the foreign currency and making investments in those countries more attractive.

A domestic budget deficit can also lead to a rise in interest rates, as the government borrows to finance the deficit, thereby increasing demand in markets for financial capital and placing upward pressure on rates. On the opposite end, increasing the money supply would often lead to lower interest rates as there is more capital available to lend.