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Suppose that a nation is at full employment without inflation but has a deficit in its...

Suppose that a nation is at full employment without inflation but has a deficit in its balance of payments. How can the nation's output rise as a result of the depreciation?

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A depreciation in domestic currency will make the exportable goods cheaper in world market, and imported goods will become more expensive. Therefore, export demand will rise and import demand will fall. This will lead to a rise in net exports, which will increase aggregate demand. The AD curve will shift rightward, leading to higher price level and higher output. Starting from an initial full employment output level, this will lead to an inflationary gap in short run.

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