Answer:
D. a widening trade deficit due to inflation causing an increase in costs for
products exported to foreign countries
Explanation:
- A depreciation of the US dollar means that the dollar loses value in terms of other currencies. This means an increase in the nominal exchanged rate, which is US$/OtherCurrency (more dollars are deliver by a specific amount of other currency).
- To understand why this happens, its important to know about real exchange rate. Real exchange rate can be expressed as [tex]r_e=e\times{\frac{P*}{P}}[/tex], where r is the real exchange rate, e is the nominal exchange rate (the one that we can see in the market), and P and P* are local and foreign prices respectively.
- Real exchange rate tell us how convenient is for us to export or import goods. It is a measure of the value of local goods in terms of foreign goods. The higher [tex]r_e[/tex], the more our goods worth in terms of foreign goods, and then, the more the incentives to export.
- On the other hand, the lower [tex]r_e[/tex], the less our goods and services worth in terms of foreign goods, and the more incentives to import (imports goods are cheapers when real exchanged rate is low, because P* is low in terms of P: international goods are less expensive).
- Inflation means higher values of P, and therefore, implies lower real exchange rate. This would yield in higher imports. Higher imports, ceteris paribus, imply a widening in the trade account.
- In terms of money supply and demand of money, higher imports imply less demand for dollars (to buy imported goods, we need foreign currency, so we lower our dollars demand, and increase our demand for foreign currency). A higher demand of foreign currency, will result higher nominal exchange rates, wich means depreciation.
