Question

Suppose the real exchange rate falls (perhaps from a neutral level) for the domestic currency of a country.

(a) Are domestic residents traveling abroad helped or hurt?

(b) Are domestic businesses that use foreign parts helped or hurt? (We’ll say these businesses don’t face foreign competition for their products.)

(c) Are domestic producers that face foreign competition helped or hurt? (We’ll say these producers don’t import parts.)

(d) What happens to domestic inflation?

Answer 1

When the exchange rate falls, the value of a domestic currency declines which makes imports costlier and exports cheaper

a) Hurts as the domestic residents have to shell more currency to buy foreign currency
b) Hurts as the imports are costlier
c) Helps as it favors exports and foreigners can buy goods at lesser money
d) Domestic inflation increases, with the reduced value of domestic currency, the demand for currency decreases which increases supply f currency thereby increasing inflation