How Factors Affect Exchange Rates The country of Luta has large capital flows with the United States. It has no trade with the United States and will not have trade with the United States in the future. Its interest rate is 6 percent, the same as the U.S. interest rate. Its rate of inflation is 5 percent, the same as the U.S. inflation rate. You expect that the inflation rate in Luta will rise to 8 percent this coming year, whereas the U.S. inflation rate will remain at 5 percent. You expect that Luta’s interest rate will rise to 9 percent during the next year, whereas the U.S. interest rate will remain at 6 percent. Do you think Luta’s currency will appreciate, depreciate, or remain unchanged against the dollar? Briefly explain.
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