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What is the price that balances the supply and demand in the market for foreign-currency exchange? The answer is the real exchange rate. The real exchange rate is the relative price of domestic and foreign goods and, therefore, is a key determinant of net exports. When the U.S. real exchange rate appreciates, U.S. goods become more expensive relative to foreign goods, making U.S. goods less attractive to consumers both at home and abroad. As a result, exports from the United States fall, and imports into the united states rise. For both reasons, net exports fall. Hence, an appreciation of the real exchange rate reduces the quantity of dollars demanded in the market for foreign-currency exchange. The real exchange rate adjusts to balance the supply and demand for dollar just as the price of any good adjusts to balance supply and demand for that good. If the real exchange rate were below the equilibrium level, the quantity of dollars supplied would be less than the quantity demanded. The resulting shortage of dollars would push the value of the dollar upward. Conversely, if the real exchange rate were above the equilibrium level, the quantity fo dollars supplied would exceed the quantity demanded The surplus of dollars would drive the value of the dollar downward. At the equilibrium real exchange rate, the demand for dollars to buy net exports exactly ballances the supply of dollars to be exchange into foreign currency to buy assets abroad. As we have just discussed, a lower price level in the United States lowers the U.S. interest rate. In response, some U.S. investors will seek higher returns by investing abroad. For instance, as the interest rate on U.S government bonds falls, a mutual fund might sell U.S. government bonds in order to buy German government bonds. As the mutual fund tries to move assets overseas, it increases the supply of dollars in the market for foreign-currency exchange. The increased supply of dollars causes the dollar to depreciate relative to other currencies. (That is, each dollar buy fewer units of foreign currencies.) As a result of this depreciation, foreign goods become more expensive relative to domestic goods, and this change in relative prices increases U.S. exports of goods and services and decreases U.S. imports of goods and services Net exports, which equal exports minus imports, also increase. Thus, when a fall in the U.S. price level causes U.S interest rates to fall, the real exchange rate depreciates, and this depreciation stimulates U.S. net exports and thereby increases the quantity of goods and services demanded.