Question

In an IS-LM model for an open economy, an increase in the interest rate by monetary authorities causes a:

A. capital inflow, an increase in the demand for rands, a depreciation of the exchange rate, and an improved trade balance.
B. capital outflow, a decrease in the demand for rands, a depreciation of the exchange rate, and an improved trade balance.
C. capital inflow, a decrease in the demand for rands, a depreciation of the exchange rate, and an improved trade balance.
D. capital inflow, an increase in the demand for rands, an appreciation of the exchange rate, and a deterioration of the trade balance.

Answer 1

In an IS-LM model for an open economy, an increase in the interest rate by monetary authorities leads to a capital outflow, a decrease in the demand for rands, a depreciation of the exchange rate, and an improved trade balance. The correct answer is option B.

Step-by-step explanation:

In an IS-LM model for an open economy, an increase in the interest rate by monetary authorities causes a capital outflow, a decrease in the demand for rands, a depreciation of the exchange rate, and an improved trade balance. When the interest rate increases, domestic interest rates become more attractive to foreign investors, leading to a capital outflow. This capital outflow decreases the demand for the domestic currency, causing it to depreciate in the foreign exchange market. A depreciated currency makes the country's exports cheaper and its imports more expensive, resulting in an improved trade balance.