To extend the short run to include a more sophisticated version of the trade balance, we include:

Question

Quizplus · Accepted Answer

The gap between the domestic and foreign real interest rates is a key determinant of the trade balance in the long run. If the domestic real interest rate is higher than the foreign real interest rate, capital will flow into the domestic economy, leading to an appreciation in the exchange rate and a deterioration in the trade balance. Conversely, if the domestic real interest rate is lower than the foreign real interest rate, capital will flow out of the domestic economy, leading to a depreciation in the exchange rate and an improvement in the trade balance. The other factors listed may influence the trade balance in the short run, but are not as important for determining the long-run trade balance.

To Extend the Short Run to Include a More Sophisticated