I am currently doing some research on the monetary approach to the effects of currency fluctuations on trade balance. It's been a while since I took an int econ class back in the undergrad, so I hope I can glean some understanding from the gods of macroecon. I have a good understanding of the overall assertion being made by this approach (trade balance change dissapates in the LR), but am a bit confused by the details and how equilibria are reached. One of my old textbooks summarizes it as such: when the currency depreciates, money demand shifts up, and rates rise, trade balance improves. In the LR, investors will flock towards the higher rates, and the money supply shifts right, where equilibrium will return to the initial interest rate. This doesn't really make sense to me....
What is causing the currency to depreciate here? When I think of a devalued currency, I think of an expansionary policy/decrease in rates. But here, rates increase due to the depreciation
Where is the deviation from the net zero trade balance and where does it return in terms of the process of the money market changes?
How do foreign investors affect the supply of the currency? I thought that when higher rates existed, that the demand of the currency increased (which would explain why contractionary policy leads to currency appreciation)
More as a question about the theory in general, is there empirical evidence of this? The US has had a trade deficit for a very long time. Does this approach suggest that our net exports should be zero?