Final answer:
A rise in U.S. real interest rates makes U.S. assets more attractive, leading to a stronger dollar which consequently makes foreign goods more expensive for Americans, potentially leading to a reduction in the volume of imports despite the currency appreciation.
Step-by-step explanation:
When the U.S. real interest rate rises, the return on U.S. assets becomes more attractive relative to foreign assets. This situation leads to several outcomes. First, foreign financial capital is likely to flow into the U.S., seeking the higher returns available due to the increased interest rates. This increased demand for U.S. dollars strengthens the U.S. dollar, causing it to appreciate relative to other currencies. Consequently, U.S. exports become more expensive for buyers using foreign currencies, decreasing the quantity of U.S. exports sold.
Simultaneously, the stronger dollar makes foreign goods cheaper for American consumers, which might typically lead to an increase in imports. However, since U.S. interest rate hikes make U.S. assets more attractive, Americans may buy fewer foreign bonds, thus supplying fewer U.S. dollars to foreign exchange markets, which can mitigate the increase in imports. Higher U.S. interest rates have the dual effect of decreasing the supply of U.S. dollars internationally and increasing foreign investment in U.S. assets, leading to a depreciation of foreign currencies against the dollar, thus making imports more expensive and possibly reducing the volume of imports even as the dollar appreciates.