Final answer:
If the price level falls, domestic interest rates usually fall as well to stimulate borrowing and economic activity. Interest rates across different financial markets vary and are influenced by monetary policy and supply and demand in specific markets. Internationally, higher domestic interest rates attract foreign capital, affecting currency exchange rates and potentially impacting the trade balance.
Step-by-step explanation:
Other things being the same, if the price level falls, we can generally expect domestic interest rates to fall. This is because lower price levels can lead to increased demand for goods and services, making borrowing more appealing, which in turn may lead central banks to lower interest rates to stimulate the economy. Furthermore, a lower price level compared to other countries makes domestic goods more attractive, leading to a rise in exports and potentially a surplus in the trade balance. However, it is important to note that interest rates are influenced by multiple factors and can vary across different financial markets.
The federal funds rate has a notable influence on domestic interest rates as it sets the tone for the cost of borrowing overnight funds. A change in this rate typically has a less than proportional impact on longer-term interest rates such as those for mortgages or car loans. Monetary policy plays a crucial role in the movement of interest rates across the spectrum by either inflating or deflating them. Supply and demand in specific markets remain the ultimate determinants of specific interest rates.
From an international perspective, an increase in the domestic interest rate leads to an inflow of foreign capital, appreciating the domestic currency and affecting the exchange rate. Higher interest rates make domestic bonds more appealing compared to foreign ones, thus decreasing the supply of domestic currency on the international market, which can lead to currency appreciation or depreciation with varying effects on the trade balance depending on other economic factors.