Answer the questions below.
a.Suppose the Federal Reserve raises the federal funds rate in the United States but people believe that the inflation rate will rise by more than the Fed raised the federal funds rate. What do you expect to happen to the exchange rate? Explain why. b.As the exchange rate changes in the direction you determined in part a, what happens to the prices of imports and exports in the United States and in other countries? Explain. c.What happens to net exports in the United States and in other countries that trade with the United States in the short run? In the long run? Explain.
What will be an ideal response?
| a. | The dollar would depreciate as the real interest rate declines and the inflation rate rises. |
| b. | As the dollar falls in value relative to other currencies, the prices of U.S. exports decline and the prices of imports into the U.S. rise; in other countries, export prices rise and import prices decline. |
| c. | In the short run U.S. net exports decline, but in the long run U.S. net exports increase (the J-curve effect). The opposite is true in other countries. |
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