6.5 Changes in the Foreign Exchange Market and Net Exports

When there are changes in the foreign exchange market causing the currency of the country to appreciate or depreciate, it will lead to a change in net exports.

Let's take the scenario that tourists from all over the world travel to Mexico for vacation. This will cause the demand for the peso (Mexican currency) to appreciate. When the currency appreciates, it causes Mexican goods to become more expensive, decreasing the number of exports to other countries.

Mexican consumers will also go looking for cheaper goods outside of their country, which will increase imports. As exports decrease and imports increase, the value of net exports will decrease which will decrease aggregate demand. Let's look at this situation in a graphical description:

Let's take a scenario where there is a trade war with the U.S. and tariffs are placed on Canadian exported goods. This will cause Canadian goods to become more expensive, so foreign consumers will not want to purchase them. As a result, they will be demanding less of the Canadian dollars. When the demand decreases for the Canadian dollar, it will depreciate, making those goods cheaper. As their goods become cheaper, exports will increase and imports will decrease. This will lead to an increase in aggregate demand because exports will then increase for Canadian goods and imports will decrease. Let's look at this example graphically: