Question

Suppose the USD depreciates by 10% against the bucket of world major currencies in the next year. What are the pros and cons of this for the US balance of payments?

Answer 1

When the currency depreciates, the purchasing power of the currency in real terms goes down, for example if I could purchase a notebook for $1 earlier, I would have to pay $1.25 for the same notebook after depreciation. This change in relative prices affects the Balance of Payments (BOP).

Exchange rate = Price of $ / Price of other currency

Depreciation implies decrease in Price of $

BOP = Exports - Imports

Impact on exports / imports - Selling that notebook by US merchant would have earlier fetched $1, but now the same notebook adds $1.25 to the exchequer. This clearly improves the BOP position of the US as export rises. However, it also has impact on the imports of the US in the opposite direction. Purchasing that notebook by US consumer will reduce $1.25 from the exchequer.

Seeing that the price of imports has risen, US consumer will demand less and imports will fall.

Moreover, from the exporter point of view, each notebook sold will add @1.25 instead of $1 (pre-depreciation price), implying BOP position will improve.