Answer: As the U.S. interest rate differential increases, international investors can obtain a greater return by holding U.S. assets. Therefore these investors want to buy more U.S. assets, such as bonds. But in order to buy more U.S. assets, they need more dollars. Hence the increase in the U.S. interest rate differential leads to an increase in the demand for dollars in the foreign exchange market and so the demand curve for U.S. dollars shifts rightward.
In the foreign exchange market, the demand for US dollar depend on the interest rate of US relative to foreign interest rate. What matters is not only the interest rate, but the US interest minus the foreign interest rate = US interest rate differential. The bigger the US interest rate differential, the higher is the quantity of US dollar demanded in the foreign exchange market.
Answer:
ReplyDeleteAs the U.S. interest rate differential increases, international investors can obtain a greater return by holding U.S. assets. Therefore these investors want to buy more U.S. assets, such as bonds. But in order to buy more U.S. assets, they need more dollars. Hence the increase in the U.S. interest rate differential leads to an increase in the demand for dollars in the foreign exchange market and so the demand curve for U.S. dollars shifts rightward.
In the foreign exchange market, the demand for US dollar depend on the interest rate of US relative to foreign interest rate.
ReplyDeleteWhat matters is not only the interest rate, but the US interest minus the foreign interest rate = US interest rate differential. The bigger the US interest rate differential, the higher is the quantity of US dollar demanded in the foreign exchange market.