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Question
Statistics
Posted 8 months ago
Maxistan and Ile are trading partners. The savings rate in Maxistan recently increased, which affected real interest rates there.
What effect does this have on real interest rates in Maxistan and the value of Ile's currency?
Choose 1 answer:
(A) Maxistan's real interest rate decreases and the value of lle's currency depreciates
(B) Maxistan's real interest rate increases and Ile's currency isn't affected.
(c) Maxistan's real interest rate decreases and the value of Ile's currency appreciates
(D) Maxistan's real interest rate increases and Ile's currency appreciates.
(E) Maxistan's real interest rate decreases and Ile's currency isn't affected.
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Answer from Sia
Posted 8 months ago
Solution by Steps
step 1
Understand the relationship between savings rate and real interest rates: An increase in the savings rate in an economy typically leads to an increase in the supply of loanable funds, which tends to decrease real interest rates. However, the question states that the real interest rates in Maxistan are affected, which could imply an increase due to other economic factors not mentioned in the question
step 2
Analyze the impact on the foreign exchange market: An increase in real interest rates in Maxistan would make Maxistan's financial assets more attractive to investors, leading to an inflow of capital. This increased demand for Maxistan's currency would appreciate its value. Consequently, the value of Ile's currency would depreciate relative to Maxistan's currency
step 3
Identify the correct answer choice: Based on the analysis, we are looking for an answer choice that indicates an increase in Maxistan's real interest rate and a depreciation of Ile's currency
Answer
D
Key Concept
Interest Rate Parity and Currency Value
Explanation
An increase in a country's real interest rates tends to appreciate its currency value relative to its trading partners, as it attracts more foreign capital.
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