In a small open economy with perfect capital mobility, the domestic interest rate is determined by the world interest rate. Assuming that there is no government intervention in the foreign exchange market and the country operates under a flexible exchange rate regime, which of the following statements is true when there is a sudden increase in the world interest rate? a) The domestic currency will appreciate, as capital inflows increase in pursuit of higher returns on the world market. b) The domestic currency will depreciate, as higher world interest rates discourage capital inflows and encourage domestic investors to invest abroad. c) The domestic interest rate will rise above the world interest rate as the central bank intervenes to maintain exchange rate stability. d) The domestic savings rate will adjust such that the current account balance remains unchanged regardless of changes in the world interest rate.

In a small open economy with perfect capital mobility, the domestic interest rate is determined by the world interest rate. Assuming that there is no government intervention in the foreign exchange market and the country operates under a flexible exchange rate regime, which of the following statements is true when there is a sudden increase in the world interest rate? a) The domestic currency will appreciate, as capital inflows increase in pursuit of higher returns on the world market. b) The domestic currency will depreciate, as higher world interest rates discourage capital inflows and encourage domestic investors to invest abroad. c) The domestic interest rate will rise above the world interest rate as the central bank intervenes to maintain exchange rate stability. d) The domestic savings rate will adjust such that the current account balance remains unchanged regardless of changes in the world interest rate.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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