US Interest Rates Rise: The Dollar Appreciates
Higher US interest rates pull in foreign investors, raising demand for dollars and appreciating the dollar.
US Interest Rates Rise: The Dollar Appreciates
Foreign Exchange Market (USD)Higher US interest rates pull in foreign investors, raising demand for dollars and appreciating the dollar.
Start at Equilibrium
The foreign exchange market for dollars begins in equilibrium where the demand for dollars (D$) meets the supply of dollars (S$). The exchange rate is the foreign currency price of one dollar.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
US Interest Rates Rise: The Dollar Appreciates, step by step
- 1
Start at Equilibrium
The foreign exchange market for dollars begins in equilibrium where the demand for dollars (D$) meets the supply of dollars (S$). The exchange rate is the foreign currency price of one dollar.
- 2
US Rates Rise, Demand Shifts Right
US interest rates rise relative to rates abroad, so American financial assets now offer a higher return. Foreign investors need dollars to buy those assets, so demand for dollars increases and the demand curve shifts right.
- 3
The Dollar Appreciates
At the new intersection the exchange rate is higher, so each dollar buys more foreign currency and the dollar has appreciated. The equilibrium quantity of dollars traded also rises.
- 4
Exports Fall, Imports Rise
Because the dollar is now stronger, US goods cost more in foreign currency, so US exports become less competitive and fall. Foreign goods are cheaper for Americans, so US imports rise. This is a downstream effect of the appreciation, not another shift in this market.
Where it ends up
The dollar appreciates and the equilibrium quantity of dollars traded rises, which makes US exports more expensive abroad and imports cheaper for Americans.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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