Interest Rates Drive Currency Appreciation

Steps:

• Identify policies affecting currency value via supply and demand in forex markets.
• Evaluate how each option influences foreign investment or trade balances.
• Focus on monetary tools that directly boost demand for the currency.
• Select the option that attracts capital inflows without inflationary side effects.

Why B is correct:

• Higher interest rates increase returns on domestic assets, drawing foreign investment and raising demand for the currency per the interest rate parity theory.

Why the others are wrong:

• A: Tariffs on imports raise domestic prices and may provoke retaliation, potentially weakening the currency through trade imbalances.
• C: Lower income taxes boost spending and aggregate demand, risking inflation that erodes currency value.
• D: Selling the currency floods the forex market with supply, directly depreciating its value.

Final answer: B