Question

Suppose the U.S. dollar depreciates. Which of the following is a correct description of the short-run consequences?

output and inflation both decrease

output and inflation both increase

output decreases and inflation increases

output increases and inflation decreases

Answer 1

For the short run, a depreciation in the value of the U.S. dollar would mean a decrease in the value of exports and an increase in the value of imports implying a decrease in the level of output.

Coming to inflation rate, there is an inverse relationship between the U.S. inflation rate and the trading partner's currency appreciation. Depreciation in the value of the US dollar would mean that goods and services are now costlier than earlier to purchase for the US and thus increased inflation.

Thus, a depreciation in the value of the U.S. dollar will tend to decrease the level of output and higher inflation.

Thus, Output decreases and inflation increases.

3rd Option is the correct answer.