Lecture 21
INTEREST RATES, EXCHANGE RATES AND NET EXPORTS

1. Exchange rates and Interest rates

• In the short run, exchange rates are influenced by interest rates
• If R in the United States rises:
• Foreigners will wish to invest in dollar-denominated securities
  [Increased capital inflows into the U.S.]
• Demand for dollars will increase (in the foreign-exchange market)
  [Not to be confused with the money market!]
• Result: The dollar will [appreciate / depreciate]

2. Exchange rates and Net exports

• Exports and imports are affected by changes in the value of the domestic currency
• Suppose the U.S. dollar appreciates
• This makes U.S. goods more expensive to foreign consumers...
  ... and foreign goods cheaper for American consumers
• Result: U.S. net exports will [increase / decrease]

3. Questions

1. If the Federal Reserve reduces interest rates in the U.S., the dollar will [appreciate / depreciate], causing net exports to [rise / fall]. Explain.
2. If the Japanese interest rate rises, the dollar will [strengthen / weaken] relative to the yen.
3. What are the other factors, in addition to a currency depreciation, that will lead to:
   • An increase in exports?
   • A decrease in imports?