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Principles of Economics- Mankiw (5th) 685

Principles of Economics- Mankiw (5th) 685 - CHAPTER 31 A G...

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CHAPTER 31 AGGREGATE DEMAND AND AGGREGATE SUPPLY 709 interest rates. Lower interest rates, in turn, encourage borrowing by firms that want to invest in new plants and equipment and by households who want to in- vest in new housing. Thus, a lower price level reduces the interest rate, encourages greater spending on investment goods, and thereby increases the quantity of goods and services demanded. The Price Level and Net Expor ts: The Exchange-Rate Ef- fect As we have just discussed, a lower price level in the United States lowers the U.S. interest rate. In response, some U.S. investors will seek higher returns by investing abroad. For instance, as the interest rate on U.S. government bonds falls, a mutual fund might sell U.S. government bonds in order to buy German govern- ment bonds. As the mutual fund tries to move assets overseas, it increases the sup- ply of dollars in the market for foreign-currency exchange. The increased supply of dollars causes the dollar to depreciate relative to other currencies. Because each
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