Answer to Question #274908 in Macroeconomics for Tenn

Question

Recall that an exchange rate is the price of one currency in another. For example, it may take US $1.35 to buy 1 British Pound. Also recall the interest rates affect exchange rates. What do you predict will happen to the foreign exchange rate if interest rates in the United States increase more than in the UK? (In other words, which currency will become stronger?) How would such a change affect US exports to the UK? Would it be less expensive for an American tourist to take a vacation to London after the interest rate change? Be sure to clearly explain and justify your reasoning. 

Answer 1

Solution:

When the interest rate of the United States increases more than in the UK, this will result in the increase in the value of the dollar making it stronger than the British pound.

Higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country's currency.

A stronger dollar makes US exports less competitive – reducing exports and increasing imports.

The same change makes American imports more expensive for the British also makes your dollar worth more in London, making your holiday cheaper.