Purpose:

To show the effect of exchange rates on trade and domestic growth and inflation, and the effect of domestic economic events on foreign exchange rates.

Objectives:

1. If the value of the dollar compared to other currencies increases, goods exported from the U.S. will cost more in terms of foreign currencies than before, and imports will cost less than before. Therefore, net exports will tend to fall, depressing economic growth in the U.S. and stimulating growth overseas.
2. A country’s ability to import and export changes over time because of underlying changes in relative wage rates, productivity, technology, etc. When such long-term changes occur, either the exchange rates have to be realigned or the country which has lost its competitive ability will have to endure a long period of slow growth in order to restore the trade balance.
3. The following will tend to cause the dollar to fall vis-à-vis foreign currencies:
   
   
   1. a higher real growth rate in the U.S. (because it will cause net exports to fall);
   2. a higher inflation rate in the U.S. (because people will want to hold currencies that are not depreciating);
   3. a lower interest rate in the U.S. (because people will convert their dollars to foreign currencies to earn high interest);
   4. pessimism regarding the relative value of investment opportunities in the U.S. The converse of these effects will cause the dollar to rise.
4. While flexible exchange rates are more volatile than fixed exchange rates, they tend to create fewer distortions and macroeconomic challenges.