Question 45

Increased money supply leads to higher demand for the dollar, causing it to appreciate.

When the U.S. central bank increases the money supply, it often stimulates demand for the dollar, which can lead to an appreciation of its value in the foreign exchange market.

A) ‘ demand for $, dollar appreciates

This option is correct because an increase in the money supply can lead to increased liquidity in the economy, which may boost demand for the dollar as investors seek to take advantage of the lower interest rates associated with a higher money supply. As demand rises, the dollar appreciates in value.

B) ‘ supply of $, dollar appreciates

This option is incorrect because while an increase in the supply of dollars generally leads to a depreciation of the currency, it does not directly relate to the appreciation of the dollar. Simply increasing the supply does not automatically increase its value; rather, it can lead to inflationary pressures that weaken the dollar.

C) “ supply of $, dollar depreciates

This option is partially correct in that an increased supply of dollars can lead to depreciation; however, it fails to address the dynamics of demand and the specific context of the question regarding appreciation. The focus of the question is on how the increased money supply influences demand and subsequent value, not just supply.

D) “ demand for $, dollar depreciates

This option is incorrect as it contradicts the economic principle that increased demand for a currency typically leads to its appreciation. In this scenario, if demand for the dollar were to decline, it would lead to depreciation, which is not aligned with the effects of increasing the money supply.

Conclusion

The rationale for the correct answer, A, hinges on the relationship between money supply and demand for the dollar. While increased money supply can lead to various effects, in this context, it stimulates demand, which in turn causes the dollar to appreciate. Options B, C, and D do not adequately capture this relationship and misrepresent the effects of monetary policy on currency value.