ABSTRACT
This chapter discusses the relationship between output and the exchange rate, and how monetary and fiscal policy affects these two variables. The gross national product of a nation (GNP) is equivalent to the market value of all final goods and services produced by a nation over a period of time, which is usually a year. When potential and actual GNP are expected to be equal, the national economy is anticipated to operate at full employment equilibrium. A change in the exchange rate affects the flow of goods and services in two ways. The first and more obvious is the value effect; the second is the volume effect. Understanding the relationship between the exchange rate and output in the short run is critical to comprehend how an open economy operates. The demand for money rises when the interest rate falls because a fall in the interest rate makes interest-bearing bank deposits less attractive to hold.
