Suppose the Fed increases the U.S. money supply through an open market purchase

Question

Suppose the Fed increases the U.S. money supply through an open market purchase of bonds. What additional effect occurs that would not be felt if the U.S. economy were closed to foreign trade? The U.S. interest rate falls, making U.S. assets less attractive to foreigners and leading to a decreased supply of and increased demand for foreign currency, causing a depreciation of the dollar and an increase in U.S. net exports. The U.S. interest rate rises, making U.S. assets more attractive to foreigners and leading to a decreased supply of and increased demand for foreign currency, causing a depreciation of the dollar and an increase in U.S. net exports. The U.S. interest rate rises, making U.S. assets more attractive to foreigners and leading to an increased supply of and decreased demand for foreign currency, causing an appreciation of the dollar and a decrease in U.S. net exports. The U.S. interest rate falls, making U.S. assets less attractive to foreigners and leading to an increased supply of and increased demand for foreign currency, causing an appreciation of the dollar and an increase in U.S. net exports. The U.S. interest rate falls, making U.S. assets more attractive to foreigners and leading to an increased supply of and decreased demand for foreign currency, causing an appreciation of the dollar and an increase in U.S. net exports.

Explanation / Answer

A.As interest rates fall, there will normally be fewer investments in the U.S., and hence a smaller supply of foreign currency to buy U.S. dollars. There will be more investments outside the U.S . causing a greater demand for foreign currency.

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