Domestic Interest Rate, iD Suppose that dollar assets pay an interest rate of iD.When the domestic interest rate on dollar assets, iD, rises, holding the currentexchange rate Et and everything else constant, the return on dollar assets increasesrelative to foreign assets, so people will want to hold more dollar assets. The quantityof dollar assets demanded increases at every value of the exchange rate, as shownby the rightward shift of the demand curve in Figure 15.4 from D1 to D2. The newequilibrium is reached at point 2, the intersection of D2 and S, and the equilibriumexchange rate rises from E1 to E2. An increase in the domestic interest rateiD shifts the demand curve for domestic assets, D, to the right and causesthe domestic currency to appreciate (E ).
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