Question 48

Higher US interest rates attract foreign capital, causing the dollar to appreciate.

Higher interest rates in the US make investments in dollar-denominated assets more attractive, leading to an increase in demand for the dollar. As foreign capital flows into the US, it results in the appreciation of the dollar.

A) depreciate

This option is incorrect because higher US interest rates typically lead to an increase in the value of the dollar, not a decrease. A depreciation of the dollar would imply that it is losing value against other currencies, which contradicts the effect of attracting foreign capital.

B) no change

This option is also incorrect. An increase in US interest rates is likely to influence currency value, leading to an appreciation rather than no change at all. Market dynamics suggest that foreign investors will respond to higher rates by increasing their investment in US assets, thereby affecting the dollar's value.

C) appreciate

This option is correct. Higher US interest rates create a more favorable environment for foreign investment, resulting in a greater demand for the dollar. As investors convert their currencies to dollars to take advantage of higher yields, the dollar appreciates in value.

D) fixed

This option is incorrect as it suggests that the dollar's value is set and unchanging. In a floating exchange rate system, which the US operates under, currency values fluctuate based on economic factors, including interest rates. Thus, a fixed value does not apply in this context.

Conclusion

The appreciation of the dollar in response to higher US interest rates is a fundamental principle in international finance. Other options fail to capture the dynamic nature of currency valuation influenced by interest rates, as they either suggest depreciation, no change, or a fixed value, which do not align with economic theory or empirical evidence.