I understand how changes in interest rates affect the demand for currency (i.e. foreign exchange), but was wondering whether there is also an effect on its supply. I am hypothesising the following: high interest rates -> lower MPC -> people spend less on imports -> will supply fewer domestic currency in exchange for foreign currency -> reduces supply of currency in the FX market. Does such a hypothesis sound at all credible? Is there another way in which the interest rates can affect the supply of a currency?

  • $\begingroup$ Do you mean notes and coins in circulation (M0) or by currency do you mean money more generally to include checking deposits and the like (M2)? $\endgroup$ – BKay Feb 17 '17 at 14:12
  • $\begingroup$ Typically, the Fed manipulates currency stock to bring the effective federal funds rate into alignment with the desired federal funds rate. That is, the direction of causality is usually the reverse of what you propose here; changes in the money stock cause changes in federal funds rate, which puts pressure on other interest rates. $\endgroup$ – 123 Feb 17 '17 at 15:29
  • $\begingroup$ I guess that you are interested in the value of a currency. "Supply of currency" is ambiguous, as supply typically corresponds a quantity, and currency often refers to the notes and coins in circulation. Therefore, "supply of currency" might be interpreted as a component of the money supply. The relationship between currency value and interest rates falls under the concept of "uncovered interest rate parity." I would refer you this question as an example: economics.stackexchange.com/questions/4914/… $\endgroup$ – Brian Romanchuk Apr 23 '17 at 21:44

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