Question
Assume that the level of capital flows between the U.S. and the country of Zeus is negligible (close to zero) and will continue to be
Assume that the level of capital flows between the U.S. and the country of Zeus is negligible (close to zero) and will continue to be negligible. There is a substantial amount of trade between the U.S. and the country of Zeus. The main import by the U.S. is basic clothing purchased by U.S. retail stores from Zeus, while the main import by Zeus is special computer chips that are only made in the U.S. and are needed by many manufacturers in Zeus. Suddenly, the U.S. government decides to impose a 20% tax on the clothing imports. The Zeus government immediately retaliates by imposing a 20% tax on the computer chip imports. Second, the Zeus government immediately imposes a 60% 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 U.S. Do you think the currency of Zeus (called the zee) will appreciate or depreciate against the dollar as a result of all the government actions described above? Explain.
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