Question

Exchange Rate Effect on Trade Balance Would the U.S. balance-of-trade deficit be larger or smaller if the dollar depreciates against all currencies, versus depreciating against some currencies but appreciating against others? Explain.

Answer 1

Balance of Trade refers to the difference in import and export values of a country during a speicific time period. It constitutes the maximum portion of a nation's Balance of Payments. A country with higher imports than exports will have a trade deficit during the period, whereas a country with a higher export value than imports will have a trade surplus for the period.

If dollar weakens against all other currencies, then this will mean that 1 dollar will depreciate in value and hence this will discourage the importers to import from other countries as they would have to shell out more money than they had expected. Hence imports will fall leading to a decline in trade deficit.

On the other hand, if US dollar strengthens against few currencies and weakens against some others, then this would mean that the importers would shift their purchases to those nations whose currencies have weakened against dollar. Thus the trade deficit might or might not fall.