Currently, interest rate earnings in the US are taxed at the same rate of the income tax rate. Suppose the tax on interest rate earnings is removed. Explain the effects of a removal of this tax on the following variables: spot dollar-euro exchange rate, dollar interest rate, euro interest rate, US exports and US imports.

In the given scenario, the dollar interest rate increases as the tax on interest rate earnings is removed,. Thus, the interest rate parity condition is given below:

iH = iF + Ee/E - 1, where "iH=dollar interest rate" and "iF = euro interest rate" and "E=spot dollar-euro exchange rate".

"iH" increases supposing the tax is removed, and in order to maintain the equality, "E" must decrease. Therefore, dollar-euro exchange rate decreases, Export will also decrease and import will increase. The euro interest rate will remain the same.