Assume an economy operates at full employment and faces a trade deficit.According to the absorption approach, currency devaluation will improve the trade balance if domestic

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According to the absorption approach, a currency devaluation will improve the trade balance if spending is cut, thus freeing resources to produce exports. This is because a devaluation makes exports cheaper in foreign markets, stimulating demand for domestic goods, while imports become more expensive, discouraging imports. By cutting spending, resources are diverted towards export production, which allows the country to increase its exports and reduce its trade deficit. Interest rates and income do not directly affect the trade balance according to this approach.

Assume an Economy Operates at Full Employment and Faces a Trade