Empirical evidence regarding the effects of currency devaluation on the balance of trade indicates that
A) complete exchange-rate pass-through generally occurs.
B) partial exchange-rate pass-through generally occurs.
C) currency devaluations always improve the trade balance in the short run.
D) currency devaluations always worsen the trade balance in the long run.

Question

Quizplus · Accepted Answer

Empirical evidence shows that complete exchange-rate pass-through does not generally occur, but rather partial exchange-rate pass-through is more common. This means that a currency devaluation may not fully translate into a proportional change in trade volumes, and the effects on the balance of trade may be less drastic than expected. However, the other two options are not accurate: currency devaluations may not always improve the trade balance in the short run (as it depends on various factors such as elasticities, competitiveness, and availability of substitutes), and they may not always worsen the trade balance in the long run (as the J-curve effect suggests that an initial worsening may give way to a later improvement as domestic producers adjust and foreign consumers react).

Empirical Evidence Regarding the Effects of Currency Devaluation on the Balance