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Exchange Rate & Trade Deficit

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Assume that foreigners are selling their investment holdings in Country A's financial markets (net capital outflow) and that Country A's trade deficit is widening. Assuming no other forces are affecting exchange rates, answer the following questions:

20. What happens to Country A's exchange rate and why?
21. Does the change in the exchange rate lead to an increase in imports or a decrease in imports? Why?
22. What should eventually happen to the trade deficit due to the expected exchange rate movement?

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20. What happens to Country A's exchange rate and why?
When foreigners are dumping their investment holdings in country A, the currency market is flooded with the money of country A. This means the currency of country A has more supply than demand. This in turn leads to a decrease in the currency value of country A compared ...

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