Question

Explain why a depreciation of the nation's currency will not correct the deficit unless real output rises or domestic expenditures (absorption) fall.

Answer 1

the absorption approach to correct the balance of payment tells us that, to correct a depreciation in a nations currency we need to produce more and absorbe less. that is produce more so that export can be encouraged and absorbe less that is to reduce import. as the currency is depriciated if we will absorbe less and produce more the demand for the nations good and services in the world market will increase because the depriciation in the nations currency makes it weaker. but if output stays intact and expenditure doesnot fall then the depriciation in nations currency will not correct the disequilibrium in the balnce of payment because we will not be able to export more.