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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

A civil war abroad causes foreign investors to seek a safe haven for their funds in the United States, leading to ________ U.S. interest rates and a _______ U.S. dollar.

a. higher, weaker

b. higher, stronger

c. lower, weaker

d. lower, stronger

To determine

The impact of capital inflow on the exchange rate and interest rate.

Explanation

The interest rate determined at the supply and demand intersection in the lonable fund market is known as the real interest rate; the same rate determined in the currency exchange market is known as the real exchange rate.

Option (d):

When the foreign capital flows into the US economy due to the civil war, it will increase the supply of currency in the market. Therefore, the real interest rate will decline in the economy which makes the real interest rate to become lower in the US economy. Since the US economy is considered as a safe place to have their funds, the demand for the US dollar will increase, which will appreciate the dollar and make it stronger against the foreign currencies. Thus, option 'd' is correct.

Option (a):

When the foreign capital flows into the US economy due to the civil war, it will increase the supply of currency in the market. Therefore, the real interest rate will decline in the economy, which makes the real interest rate to become lower in the US economy. Since the US economy is considered as a safe place to have their funds, the demand for the US dollar will increase, which will appreciate the dollar and make it stronger against the foreign currencies...

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