Trade & Open Economy · intro
What moves on the Interest Rate Parity diagram
A higher domestic rate makes home deposits more attractive at any exchange rateexchange rateThe price of one currency in terms of another.. The currency appreciates until interest parity is restored.
Investors compare returns: home deposits pay the flat line, foreign deposits the downward curve.
The home central bank hikes unexpectedly.
The domestic return line jumps up, and at the old exchange rateexchange rateThe price of one currency in terms of another. home deposits dominate.
Capital floods in and the currency appreciates instantly until expected returns are equal again. No trade flows needed: expectationsexpectationsBeliefs about the future that shape behavior today, the hinge variable of modern macroeconomics. do all the work.
Examiners ask this as: rate hike, rba raises rates, surprise tightening, cash rate up, hawkish central bank.
Other scenarios on Interest Rate Parity