Question

If the British pound and Euro are both appreciating relative to the dollar, how does this impact exports and imports, AD and GDP? What should the Fed. due to respond?

Answer 1

If British Pound and Euro are both appreciating, the value of their currency against the US Dollar is rising. Thus, the competitiveness of European products is declining whereas the competitiveness of the US products is increasing. As a result, exports will increase and imports will decrease. Thus, the net exports will increase and both AD and GDP will increase. Although, the fed does not intervene to manage the exchange rates, if it does not like a depreciated Dollar, it can raise interest rates. As a result their will be capital flow into the US and the USD will start appreciating against the Pound and the Euro.