If the Federal Reserve raises interest rates, what is the most likely effect of higher interest rates on U.S. exports?

• A. U.S. exports will decrease because the dollar appreciates, making U.S. goods more expensive abroad.
• B. U.S. exports will remain unchanged because interest rates do not affect international trade.
• C. U.S. exports will increase because higher interest rates stimulate foreign demand for U.S. goods.
• D. U.S. exports will decrease because higher interest rates reduce domestic production capacity.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the relationship between interest rates and exchange rates. When the Federal Reserve raises interest rates, it often leads to an appreciation of the U.S. dollar because higher interest rates attract foreign capital seeking better returns.
2. Step 2: Recognize how an appreciating dollar affects exports. A stronger dollar makes U.S. goods more expensive for foreign buyers since they need to spend more of their own currency to purchase the same amount of dollars.
3. Step 3: Analyze the impact on demand for U.S. exports. As U.S. goods become more expensive abroad, foreign consumers are likely to reduce their purchases of these goods, leading to a decrease in U.S. exports.
4. Step 4: Consider alternative options and why they are less likely. For example, interest rates do affect international trade through exchange rates, so exports do not remain unchanged; higher interest rates do not directly stimulate foreign demand; and the reduction in domestic production capacity is not the primary channel here.
5. Step 5: Conclude that the most likely effect of higher interest rates is a decrease in U.S. exports due to the appreciation of the dollar making U.S. goods more expensive abroad.