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Unformatted text preview: appreciation. Appreciation will lead to loss in competitiveness and net exports (NX) will be crowded out to the point where domestic output (Y) is back to the original level. In the end, level of output and interest rate will remain unchanged, and r = r*. Question 3 If the US interest rate is 4% and you expect the pound to depreciate by 6%, then the yield on British Government securities would have to be i F = 10% or more to make the purchase of British securities profitable. When capital is perfectly mobile, the domestic interest rate i' is equal to the foreign interest rate, (i F ) adjusted for the expected exchange rate depreciation (risk premium). i = i F + , where = risk premium on domestic currency. Since risk premium is on the foreign currency, = 6%. Thus, i F = 4 + 6 = 10%...
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