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How do interest rates affect the value of currency?

Posted on April 16, 2014 at 11:45 AM

Interest rates are an important determinant to the international value of a country's currency and net exports.

When interest rates increase, foreigners demand more interest-bearing bonds and more currency to purchase the bonds. This appreciates the value of the currency, which makes the country's goods look more expensive to foreigners. Exports will decrease and imports will increase.

When interest rates decrease, foreigners demand fewer interest-bearing bonds and less currency to purchase the bonds. This depreciates the value of the currency, which makes the country's goods look cheaper to foreigners*. Exports will increase and imports will decrease.

*This also makes imported economic resources to appear more expensive, which raises the costs of production in certain industries. Depending on the scale, this can be detrimental to the short-run aggregate supply curve.

AP Macroeconomics Unit 6 International Trade

Categories: AP Macroeconomics, Macro Unit 6 International Trade

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