Final answer:
An increase in the nominal exchange rate can lead to rapid export growth, rising inflation, increased unemployment, and higher oil prices. Expected exchange rates can affect yields by influencing the demand and supply of the currency. A contractionary monetary policy can cause currency appreciation, affecting trade balances and GDP.
Step-by-step explanation:
In the long run, an increase in the nominal exchange rate could lead to various economic outcomes, including:
- Extremely rapid growth of exports: If a country's currency depreciates, it could make that country's goods cheaper for foreign buyers, boosting exports.
- Rising inflation: As the currency weakens, import prices rise which can lead to inflation.
- A rise in the natural rate of unemployment: If exports do not compensate for currency devaluation and industries are unable to cope, it may lead to higher unemployment.
- A rise in oil prices: If the country is a net importer of oil, a weaker currency makes oil more expensive, contributing to inflation.
As for the impact of expected exchange rates on yields, if a country's currency is expected to appreciate in value, the demand for that currency would likely increase. Investors may expect higher returns from holding assets denominated in that currency. Consequently, there could be an increase in yields on government bonds to attract foreign investors, balancing the currency's demand and supply in the market. However, if the currency appreciation is significant, the central bank may mitigate the effect on yields to maintain export competitiveness.
Furthermore, a contractionary monetary policy would potentially cause an appreciation in the currency due to higher domestic interest rates. This would reduce exports and increase imports; hence decreasing net exports and aggregate demand, which could ultimately lead to a fall in GDP. Yet, cheaper imports might counterbalance this effect by stimulating aggregate supply and bringing GDP back in line with potential output, albeit at a lower price level.