Price Levels and Open Economy Macro - Essay Example

On the other hand, a reduction in national income reduces import in value relative to exports the resultant effect being the appreciation of the external value of currency thus strengthening real and nominal exchange rates in the long run.3. Factors such as indirect taxes, subsidies, and transport costs may change the prices of goods in a country but not affect the exchange rates. If a country imposes a tariff on imports from abroad, the price in the home market would rise but since less foreign currency would be spent on it, the long-run exchange rate will tend to improve.

The long-run nominal exchange rate will also improve.4. Short-term capital moves from one country to another as changes take place in the rate of interest being offered by each country. Governments can therefore vary interest rates to attract or repel foreign capital. The expected real interest rate of nine percent in the USA; will lead to reduced imports and increase exports which will strengthen the dollar exchange rate against the Euro. The low interest of three percent per year in Euro will attract foreign capital resulting in increased imports thereby weakening the Euro against the Dollar.