Question

What happens to the value of the dollar if the European Central Bank (ECB) increases its money supply and lowers interest rates? How will this impact the value of the dollar, exports and imports, AD and GDP?

Answer 1

When ECB increases the flow of money supply, then the purchasing power of the domestic residents increases. Higher money supply leads to currency depreciation and reduces the value of Euro against the currencies of the rest of the world.

This makes dollar' value to go up as dollar appreciation will occur.

Inexpensive Euro will increase the European Exports and decreases their imports. Consequently, the AD in Europe will increase. This will lead to increase in Europe GDP

On the other hand,

The US exports decreases and imports increase. The AD and the GDP level in US will also decline.