Currencies with higher nominal interest rates will depreciate because the higher rates reflect higher expected inflation.

Thus, the difference in interest rates between two countries reflects the expected change in exchange rates.

• IFE Prediction: The domestic currency will depreciate.
  

• Imports: More expensive, as domestic currency weakens.
  

• Exports: More competitive abroad, as foreign buyers get more for their currency.
  

• Example: Mexico (high interest/inflation) vs. U.S. (lower). The Mexican peso would depreciate relative to the dollar.
  

Implication: Trade balance may improve due to increased exports and reduced imports.

Exports: More expensive for foreign buyers, possibly reducing demand.

Example: Japan (low rates) vs. Brazil (high rates). The yen is expected to appreciate.

Implication: Trade deficit could widen due to rising imports and falling exports.

Imports/Exports: Relatively stable pricing and trade conditions.

Example: Canada and the U.S. with similar inflation and interest trends.

Implication: Exchange rate stability fosters predictable trade flows.