When does a country's currency appreciate?

When does a country's currency appreciate?

• A. Supply of the domestic currency rises
• B. Domestic inflation rises
• C. Demand for the domestic currency rises
• D. Demand for foreign currencies rises relative to the domestic currency

Answer: (C)

Appreciation happens when the domestic currency strengthens against other currencies, and the key driver is demand for that currency. When more buyers want to hold the domestic currency—perhaps because higher interest rates, better growth prospects, or safer assets attract investors—the currency’s price in foreign exchange rises. As demand increases, the value of the domestic currency goes up, meaning it can buy more foreign currency. If the domestic currency’s supply rises, its value would fall rather than rise. Higher domestic inflation tends to reduce the currency’s value as it erodes purchasing power and can lower demand relative to foreign currencies. Likewise, if demand for foreign currencies rises relative to the domestic one, people exchange domestic currency for foreign currency more, leading to depreciation of the domestic currency.

Appreciation happens when the domestic currency strengthens against other currencies, and the key driver is demand for that currency. When more buyers want to hold the domestic currency—perhaps because higher interest rates, better growth prospects, or safer assets attract investors—the currency’s price in foreign exchange rises. As demand increases, the value of the domestic currency goes up, meaning it can buy more foreign currency.

If the domestic currency’s supply rises, its value would fall rather than rise. Higher domestic inflation tends to reduce the currency’s value as it erodes purchasing power and can lower demand relative to foreign currencies. Likewise, if demand for foreign currencies rises relative to the domestic one, people exchange domestic currency for foreign currency more, leading to depreciation of the domestic currency.