Weighing Factors That Affect Exchange Rates Assume that the level of capital flows between the United States and the country of Zeus is negligible (close to zero) and will continue to be negligible. A substantial amount of trade takes place between the United States and the country of Zeus. The main import by the United States is basic clothing purchased by U.S. retail stores from Zeus, whereas the main import by Zeus is special computer chips that are made only in the United States and are needed by many manufacturers in Zeus. Suddenly, the U.S. government decides to impose a 20 percent tax on the clothing imports. The Zeus government immediately retaliates by imposing a 20 percent tax on the computer chip imports. Second, the Zeus government immediately imposes a 60 percent tax on any interest income that would be earned by Zeus investors if they buy U.S. securities. Third, the Zeus central bank raises its local interest rates so that they are now higher than interest rates in the United States. Do you think the currency of Zeus (the zee) will appreciate or depreciate against the dollar as a result of all these government actions? Explain.
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