Question

Suppose a country wants to maintain its exchange rate at the current level, but it is worried that market forces will push it down (that is, make the currency less valuable relative to other countries’ currencies).  (This is a problem that countries commonly face.  A recent examplewas in Russia in 2014-15.)  In an attempt to keep the exchange rate from falling, the country’s central bank adopts a tight money policy.

8.   Quick review: if the central bank adopts a tight money policy, do interest rates rise in the short run, or do they fall?

oa tight money policy raises interest rates in the short run

oa tight money policy reduces interest rates in the short run

9.   If interest rates move in the direction you indicated in #8, how does this affect the country’s exchange rate?  In the space below, draw a graph showing demand and supply in the market for the country’s currency in foreign exchange markets, and use your graph to show how the country’s tight money policy (and resulting changes in interest rates) would affect the exchange rate.  Be sure to label and mark your graph clearly and completely.

10.Would the country’s tight money policy help to keep its currency stronger?  Check one:

othe tight money policy would make the currency stronger(appreciate)

othe tight money policy would make the currency weaker(depreciate)