If the domestic currency depreciates, raising the nominal exchange rate but leaving other things unchanged, the real exchange rate will:
A) decrease.
B) increase.
C) not be affected.
D) none of the above.

Question

Quizplus · Accepted Answer

When the domestic currency depreciates, it means that more units of the domestic currency are needed to purchase a unit of foreign currency, effectively raising the nominal exchange rate. The real exchange rate, which adjusts the nominal exchange rate by the relative prices of domestic and foreign goods, will increase if the domestic currency depreciates and other factors remain constant. This is because the domestic goods become cheaper relative to foreign goods, making the real exchange rate—the price of domestic goods in terms of foreign goods—higher.

If the Domestic Currency Depreciates, Raising the Nominal Exchange Rate