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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

Which statement best describes how a rise in domestic interest rates, relative to those abroad, typically affects the exchange rate and net exports in a floating-rate regime?

A higher domestic interest rate relative to abroad attracts capital inflows, raising demand for the currency so it appreciates. The stronger currency makes exports more expensive and imports cheaper, so net exports tend to fall.

  1. ACapital inflows increase, the currency tends to appreciate and net exports tend to fallCorrect
  2. BCapital inflows fall, the currency tends to appreciate and net exports rise
  3. CCapital inflows increase, the currency tends to depreciate and net exports rise
  4. DCapital outflows increase, the currency tends to depreciate and net exports fall
  5. Exchange rates and net exports are unaffected by interest differentials

Explanation

Higher relative returns attract foreign capital, raising demand for the domestic currency and appreciating it. A stronger currency makes exports dearer and imports cheaper, so net exports tend to fall.

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