Financial Markets and Institutions (2-downloads)

1

2

F I G U R E   1 5 . 4

Response to an Increase in the Domestic Interest Rate, 

i

D

When the domestic interest rate 

i

D

increases, the relative expected return on domestic 

(dollar) assets increases and the demand curve shifts to the right. The equilibrium exchange

rate rises from 

E

1

to

E

2

.

S

Exchange Rate, E

t

(euros/$)

Quantity of Dollar Assets

E

1

E

2

D

1

D

2

1

2

F I G U R E   1 5 . 5

Response to an Increase in the Foreign Interest Rate, 

i

F

When the foreign interest rate 

i

F

increases, the relative expected return on domestic (dollar)

assets falls and the demand curve shifts to the left. The equilibrium exchange rate falls from

E

1

to

E

2

.

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Chapter 15 The Foreign Exchange Market