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Consider a monetary expansion at home that lowers domestic interest rates. Using one of the models...

  1. Consider a monetary expansion at home that lowers domestic interest rates. Using one of the models studied in class, discuss what impact this would have on (nominal) exchange rates. What would the impact on net exports and output in the short run?
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Answer #1

There is a reduction in the domestic interest rates. consider the fact that the country is large enough to influence world economic variables. Lower interest rates will result in capital flight and net capital outflow in the country increases. This results in depreciating the currency which means the exchange rate will decline. For foreigners domestic exports will become cheaper which means exports increase and imports decline resulting in increasing net exports. output in the short run will therefore increase as net exports increase and this increases aggregate demand.

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