From Net Exports Back to Aggregate Demand

This topic closes the loop that Unit 6 has been building. Interest rate changes move the exchange rate, the exchange rate moves net exports, and net exports are one of the four pieces of aggregate demand, alongside consumption, investment, and government spending. So a shift that starts in a currency market ends up moving output and unemployment in the real economy. When a currency depreciates, foreign buyers pay less for that country's goods, so exports rise; domestic buyers pay more for foreign goods, so imports fall. Net exports (exports minus imports) rise, autonomous spending rises, and the aggregate demand curve shifts right.

That rightward shift is a change in AD itself, a different thing from a movement along the AD curve. The AD curve slopes down because of the exchange rate effect in the first place: a lower domestic price level makes domestic goods cheaper to foreigners, raising net exports, which is one reason higher price levels are paired with lower quantity demanded. So the exchange rate channel shows up twice: it is part of why AD slopes down, and it also shifts AD when the exchange rate moves for reasons unrelated to the domestic price level, like a foreign interest rate change.

The rise in net exports does not raise GDP dollar for dollar. It is an injection of autonomous spending that then circulates: the firm that earns the export revenue pays workers, who spend part of their paychecks, who generate income for someone else, and so on. The spending multiplier captures that chain, so the eventual change in real GDP is the change in net exports times the multiplier.