Suppose that Argentina's dollar-denominated external assets and liabilities are $10 billion and $100 billion, respectively, and its Argentine peso-denominated external assets and liabilities are each 50 billion pesos (P). Suppose further that Argentina fixes its exchange rate at P1 = $US1. What is the likely effect of the change in Argentina's external wealth on Argentine aggregate demand as a result of the devaluation of the peso (from P1 = $US1 to P3 = $US1)?
A) It will increase Argentine aggregate demand.
B) It will decrease Argentine aggregate demand.
C) It will neither increase nor decrease Argentine aggregate demand.
D) It will first increase, then decrease Argentine aggregate demand.

Question

Quizplus · Accepted Answer

The devaluation of the peso (from P1 = $US1 to P3 = $US1) means that Argentina's external liabilities in dollars have increased, while its external assets in dollars remain the same. This leads to a decrease in Argentina's net external wealth, which in turn reduces the country's ability to finance imports and to save. As a result, there is a decrease in Argentine aggregate demand.

Suppose That Argentina's Dollar-Denominated External Assets and Liabilities Are $10