Farshad

39. Explain how changes in interest rates can be expected to affect exchange rates.

The interest rate connects the price of goods today and their price in the future. If a country's interest rate changes due to an increase in quantity demanded for loanable funds then this would lead to an increase in the interest rate in that country which is an attraction to international investors. Countries with higher short-term interest rate attract more foreign investors than the ones with lower interest rate currencies. This is because higher interest rate will be the beneficiaries of capital mobility. For foreign investors to buy capital in another country, it would mean for them to buy the currency of that good which will increase the quantity demanded for the currency and shift the demand curve to the right. This would lead to the appreciation of that currency which will increase its exchange rate against other countries.