Question

Suppose U.S. interest rates decline compared to the rest of the world. What would be the likely impact on the demand for dollars, supply of dollars, and exchange rate for dollars compared to, say, euros?

Short answer

Lower U.S. interest rates make U.S. support less desirable compared to support in the European Union.

Step-by-step solution

Concept introduction

The foreign exchange demand in the market on which other country's (international) funds (currency bank balances, banknotes, drafts, and checks) are traded.

Explanation

A decline in the interest rate would make investment in the US less attractive. The decrease in investment would further cause a reduction demand for dollars. The supply of dollars in the foreign exchange market would increase. This would cause the value of dollar to depricate. The exchange rate of dolalrs in comparison to euros would fall as well.