interest rates increase in Mistyville but not in Silvania Using foreign exchange graph for Silvania, show and explain the impact of the change in interest rates on each of the following:

Question

(i)the supply of Silvania's dollar.

(ii)the international value of Silvania's dollar.

(iii)Silvania's net exports.

Answer 1

Money will flow toward the higher interest rate country as savers and investors realize they can earn higher profits there. That will cause an increase in the demand for the currency of the higher interest rate country, in this case Mistyville. This will cause an increase in the supply of Silvania's dollars on the forex market. It will cause a decrease in the value of the Silvania dollar. Since the currency of Silvania is now relatively cheaper, exports from this country will increase and imports will be more expensive and will fall. Net exports will increase.