16.4 Real exchange rates affect the payments for imports and exports, and also affect the current account. Inflation leads to higher prices for exports, reducing their demand and worsening the current account. And greater domestic disposable income also worsens the current account as consumers increase spending on imports.
Interest rates can differ between countries due to expected exchange rate changes (Δε) and a risk premium (x) when capital is not perfectly substitutable between countries.
rUS = rUK − Δε + x
Interest rates can differ between countries due to expected exchange rate changes (Δε) and a risk premium (x) when capital is not perfectly substitutable between countries.
rUS = rUK − Δε + x