When the dollar's value changes, the prices of U.S. exports and imports change too. That moves net exports, and net exports are part of aggregate demand. Pick a cause in the market for dollars or move the exchange rate directly, then follow the chain to real GDP and the price level.
Dashed grey lines show the starting position: €0.80 per dollar, net exports of −40 billion, and an economy at full employment. Solid lines show where things are now.
When the dollar depreciates, each dollar buys fewer euros. U.S. goods get cheaper for Europeans, so U.S. exports rise. European goods get more expensive for Americans, so U.S. imports fall. Net exports increase.
When the dollar appreciates, U.S. goods get more expensive abroad and foreign goods get cheaper at home. U.S. exports fall, imports rise, and net exports decrease.
Net exports are a component of aggregate demand. A depreciation raises net exports and shifts AD right, so real GDP and the price level rise in the short run. An appreciation shifts AD left, so both fall.
The balance of trade (net exports of goods and services) is the largest part of the current account. A depreciation moves the current account toward surplus. Because the balance of payments sums to zero, the capital and financial account moves by the same amount in the other direction.
If the dollar appreciates against the euro, the euro depreciates against the dollar. Europe's net exports to the U.S. then rise while U.S. net exports fall.
A change in the U.S. price level changes net exports and moves the economy along AD. A change in the exchange rate from some other cause, like interest rates or asset preferences, shifts the whole AD curve.
Each row is a chain to write out on an FRQ: shift in the market for dollars, then the dollar, then trade, then AD, then output and prices.
| Event | Market for dollars | Dollar | U.S. exports / imports | Net exports and current account | U.S. AD, real GDP, price level |
|---|---|---|---|---|---|
| U.S. real interest rates rise relative to other countries | Demand right | Appreciates | Exports ↓, imports ↑ | ↓, current account toward deficit | AD left; real GDP ↓, price level ↓ |
| Fed lowers interest rates (expansionary monetary policy) | Demand left (and supply right) | Depreciates | Exports ↑, imports ↓ | ↑, current account toward surplus | AD right; adds to the boost from more investment |
| Foreign investors want more U.S. stocks and bonds | Demand right | Appreciates | Exports ↓, imports ↑ | ↓; the financial account inflow is matched by a current account fall | AD left; real GDP ↓, price level ↓ |
| Americans buy more foreign financial assets | Supply right | Depreciates | Exports ↑, imports ↓ | ↑, current account toward surplus | AD right; real GDP ↑, price level ↑ |
| Expansionary fiscal policy raises U.S. real interest rates | Demand right | Appreciates | Exports ↓, imports ↑ | ↓ | Lower net exports partly offset the AD increase from fiscal policy |
| Speculators expect the dollar to fall | Demand left and supply right | Depreciates | Exports ↑, imports ↓ | ↑ | AD right; real GDP ↑, price level ↑ |
AP-style multiple choice. Pick an answer to see the explanation.
The vocabulary for topic 6.5. Read the list, flip through flashcards, or quiz yourself. For every term in the unit, see the Unit 6 terminology guide.