Suppose a country is perceived to have an overvalued real exchange rate does not devalue.Which of the following would we expect to occur over time?
A)a reduction in its price level
B)a real depreciation of its currency
C)a reduction in its trade surplus
D)all of the above
E) none of the above

Question

Quizplus · Accepted Answer

An overvalued real exchange rate makes the country's exports more expensive and imports cheaper, leading to a trade deficit. To correct this, the country would need to devalue its currency, making exports cheaper and imports more expensive. However, if the country does not devalue, we would expect the following to occur over time:* A reduction in its price level: As the country's exports become more expensive, demand for them will decrease. This will lead to a decrease in the country's overall price level.* A real depreciation of its currency: As the country's price level decreases, the real value of its currency will also decrease. This will make the country's exports more competitive and imports more expensive, leading to a real depreciation of the currency.* A reduction in its trade deficit: As the country's exports become cheaper and imports more expensive, the country's trade deficit will decrease.

Suppose a Country Is Perceived to Have an Overvalued Real