If the central bank of Sri Lanka increases interest rates and the Reserve Bank of Australia decreases interest rates. Ceteris paribus, we should expect

Question

BlackTom AI · Accepted Answer

Higher interest rates in Sri Lanka and lower rates in Australia change expected returns on financial assets, so capital flows shift toward Sri Lanka and away from Australia.

1) Relevant concepts
- Interest-rate differential: investors seek higher nominal returns, so higher domestic rates attract foreign capital.
- Exchange-rate determination: increased demand for a currency (to buy assets denominated in that currency) causes that currency to appreciate; decreased demand causes depreciation.
- Ceteris paribus: holding other factors (risk, capital controls, expectations) constant.

2) Step-by-step reasoning
- Sri Lanka raises its policy rate. Foreign and domestic investors now get relatively higher returns on Sri Lankan assets.
- To buy Sri Lankan assets, investors need Sri Lankan rupees (LKR). Demand for LKR rises.
- Increased demand for LKR bids up its price relative to other currencies (appreciation of LKR).
- Australia cuts its policy rate. Australian assets become less attractive to foreign investors.
- Demand for Australian dollars (AUD) falls, so AUD depreciates relative to other currencies.

3) Intermediate steps / simple numeric illustration
- Suppose initially 1 AUD = 100 LKR. After capital shifts to Sri Lanka, demand for LKR increases so the rate might move to 1 AUD = 90 LKR. This means AUD has fallen relative to LKR and LKR has risen relative to AUD.

4) Why the correct answer is correct
- Statement (a) says AUD will fall relative to LKR — correct because lower Australian rates reduce demand for AUD.
- Statement (b) says LKR will rise relative to AUD — correct because higher Sri Lankan rates increase demand for LKR.
- Both statements describe the same directional change from two perspectives (one in terms of AUD, one in terms of LKR).

5) Why other options are incorrect
- Option (c) (both currencies fall) is inconsistent: one currency must appreciate if the other depreciates in a bilateral rate; both cannot fall relative to each other. Options (a) and (b) are individually true but incomplete alone.

6) Conclusion
Both (a) and (b) are correct; therefore the correct choice is d. Both A and B are correct.

If the central bank of Sri Lanka increases interest rates and the Reserve Bank of Australia decreases interest rates. Ceteris paribus, we should expect单项选择题

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