Which curve shifts and what happens to exchange rate

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Suppose that US and Mexico are each other’s sole trading partners. The Fed, afraid that the economy is about to overheat, raises the U.S. interest rate.

Will the dollar appreciate or depreciate against the Mexican peso? Illustrate with a diagram of the dollar peso foreign exchange market. (Similar to the Figure 3 Ch 29 Exchange rates and Macroeconomic policy)). What happens when interest rate in US changes relative to Mexico? Which curve shifts and what happens to exchange rate?

Reference no: EM131387449

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