CHAPTER 31AGGREGATE DEMAND AND AGGREGATE SUPPLY709interest rates. Lower interest rates, in turn, encourage borrowing by firms thatwant 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, encouragesgreater spending on investment goods, and thereby increases the quantity of goods andservices demanded.The Price Level and Net Expor ts:The Exchange-Rate Ef-fectAs we have just discussed, a lower price level in the United States lowersthe U.S. interest rate. In response, some U.S. investors will seek higher returns byinvesting 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 supplyof dollars causes the dollar to depreciate relative to other currencies. Because each
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