Assume that an economic boom occurs in the United States, so that the United States has a much higher growth rate than other nations. What will happen to the exchange rate of the U.S. dollar?

What will be an ideal response?

The boom in the United States will lead to an increase in demand for goods and services, including foreign-made goods and services. (Recall the Keynesian consumption function relating income and consumption spending.) The increase in demand for foreign-made items (increase in imports) will increase the supply of dollars offered in the foreign-exchange market and tend to decrease the equilibrium price. The exchange rate will fall—0the dollar will depreciate—compared to other currencies.