When the real exchange rate of the Japanese yen depreciates,
A) the yen's nominal exchange rate must also depreciate.
B) the yen's nominal exchange rate must remain constant.
C) the yen will trade for more units of a foreign currency.
D) the yen will trade for fewer units of a foreign currency.

Question

Quizplus · Accepted Answer

When the real exchange rate of a currency depreciates, it means that the currency has become relatively cheaper compared to the currencies of its trading partners. This leads to a decrease in the demand for the currency and an increase in the supply of the currency in the foreign exchange market. As a result, the currency's nominal exchange rate (the price of the currency in terms of another currency) must also decrease in order to equilibrate the market. This means that the currency will trade for fewer units of a foreign currency. Therefore, option D is the best choice.

When the Real Exchange Rate of the Japanese Yen Depreciates