Trade & Open Economy · intro
What moves on the Interest Rate Parity diagram
Higher foreign rates shift the foreign return schedule out, and the home currency must depreciate until expected returns equalize again.
Parity holds: both deposits offer the same expected return at the current exchange rateexchange rateThe price of one currency in terms of another..
The Fed raises rates while the home central bank does nothing.
The foreign return curve shifts out: at any exchange rateexchange rateThe price of one currency in terms of another., foreign deposits now pay more.
Capital flows out and the home currency depreciates to the new crossing. This is why emerging-market currencies wobble every time the Fed tightens.
Examiners ask this as: fed hike, foreign rates rise, us tightening, interest differential, capital outflow.
Other scenarios on Interest Rate Parity