Question

When foreign interest rates are low relative to those in the U.S., demand for dollars will tend to ________?

1) increase
2) decrease
3) remain unchanged
4) fluctuate

Answer 1

When foreign interest rates are low relative to those in the U.S., the demand for dollars will tend to increase. Lower U.S. interest rates make U.S. assets less desirable compared to assets in foreign countries, leading to an increase in demand for their currency.

Step-by-step explanation:

When foreign interest rates are low relative to those in the U.S., the demand for dollars will tend to increase.

Lower U.S. interest rates make U.S. assets less desirable compared to assets in foreign countries. As a result, investors will seek to invest in countries with higher interest rates, which increases the demand for their currency. Since foreign interest rates are low, investors will find U.S. assets more attractive, leading to an increase in demand for dollars.

To further illustrate this, let's consider the impact on the exchange rate between dollars and euros. With lower U.S. interest rates, the decrease in demand for dollars would cause the supply of dollars to increase in foreign currency markets. This increase in supply and decrease in demand for dollars would result in the dollar depreciating compared to the euro.