How does a trade deficit affect the exchange rate for a country's currency?A.A stable trade deficit leads to a lower exchange rate for the country's currency.B.A growing trade deficit leads to a higher exchange rate for the country's currency.C.A stable trade deficit leads to a higher exchange rate for the country's currency.D.A growing trade deficit leads to a lower exchange rate for the country's currency.
Question
How does a trade deficit affect the exchange rate for a country's currency?A.A stable trade deficit leads to a lower exchange rate for the country's currency.B.A growing trade deficit leads to a higher exchange rate for the country's currency.C.A stable trade deficit leads to a higher exchange rate for the country's currency.D.A growing trade deficit leads to a lower exchange rate for the country's currency.
Solution
D. A growing trade deficit leads to a lower exchange rate for the country's currency.
Here's why:
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A trade deficit means that a country is importing more goods and services than it is exporting. This means there is a higher demand for foreign currencies (to pay for the imports) than there is for the home country's currency (from exports).
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This increased demand for foreign currencies relative to the home currency puts downward pressure on the value of the home currency. This is because the supply of the home currency on the foreign exchange market is increasing (as it is being sold to pay for imports) while the demand for it is decreasing (as there are fewer exports being paid for in the home currency).
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As a result, the exchange rate (the value of the home currency relative to other currencies) decreases. This means that the home currency is worth less compared to other currencies.
So, a growing trade deficit generally leads to a lower exchange rate for the country's currency.
Similar Questions
A rapidly growing trade deficit affects a country's currency by:A.causing its value to drop relative to other currencies.B.allowing its value to inflate at a rate determined by the country.C.causing it to use a fixed rather than a flexible exchange rate.D.preventing it from being used in international trade.
Which of the following explains why a budget deficit can cause a trade deficit?aAn increase in the budget deficit raises domestic interest rates, resulting in a current accountsurplus and an appreciation of its currency.bAn increase in the budget deficit lowers domestic interest rates, resulting in a currentaccount deficit and a depreciation of the currency.cAn increase in the budget deficit raises domestic interest rates, resulting in a capitalaccount surplus and an appreciation of the currency.dAn increase in the budget deficit lowers domestic interest rates, resulting in a capitalaccount deficit and a depreciation of the currency
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The impact of changes in exchange rates on the economy includes:Question 49Answera.Influencing trade balances and capital flowsb.Shifting monetary policy goalsc.Changing labor force participation ratesd.Determining government spending priorities
Explain how a high current account deficit might affect the exchange rate
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