If a country's currency is overvalued in real terms, what combination of exchange rate and price changes will cause its exchange rate to move toward its real equilibrium value?
A) currency depreciation and deflation
B) currency depreciation and inflation
C) currency appreciation and deflation
D) currency appreciation and inflation

Question

Quizplus · Accepted Answer

If a country's currency is overvalued in real terms, it means that the currency is priced higher than its true value. In order to move towards its real equilibrium value, the country's currency needs to depreciate, which will result in a cheaper price in terms of other currencies. At the same time, deflation will help to reduce domestic prices, which will further support the depreciation of the currency and push it towards its real value. Therefore, the correct combination is currency depreciation and deflation.

If a Country's Currency Is Overvalued in Real Terms, What