I had worked out in my mind why higher nominal interest rates lead to currency depreciation, thanks to help from some of you the other day. then i come across the explanation to question 115 on this exam, where schweser says the exact opposite. wtf??? Rising nominal Bundovian interest rates will increase the demand for BU and decrease the supply of BU. The increase in demand, all else equal, will cause the BU to appreciate and increase the equilibrium quantity. The decrease in supply, all else equal, will also cause the BU to appreciate but decrease the equilibrium quantity demanded. The net effect of these two changes is to cause the BU to appreciate. However, the separate effects on quantity demanded will offset and the equilibrium quantity will not be significantly affected. (Study Session 4, LOS 17.c and 19.d)
It really depends. If real rates go up -> currency appreciates, if inflation goes up -> currency depreciates.
I had exactly the same reasonning as ng30 and still cannot understand why I had it wrong. Nothing in the vignette was telling us about inflation or real rates. Anyone?
this is the supply -demand curve -with both supply and demand affected by the same factors. higher rates do increase the demand for a currency and decrease the supply. we dont have any information to conclude if this “equilibrium” level will further adjust because the rates are up solely because of inflation.