When we measure the impact of exchange rate changes on a nation's trade balance, the bilateral exchange rates explain only part of the change. To assess the overall change, we need to calculate:
A) the home multilateral exchange rate, or real effective exchange rate.
B) a nation's income versus income changes in the rest of the world.
C) a nation's marginal propensity to consume imports.
D) the movement over time of the trade balance along with long-run expectations of the exchange rate.

Question

Quizplus · Accepted Answer

Bilateral exchange rates only provide a partial explanation of the impact of exchange rate changes on a nation's trade balance. To assess the overall change, we need to calculate the home multilateral exchange rate, also known as the real effective exchange rate. This takes into account the trade-weighted average of a nation's bilateral exchange rates with other countries and adjusts for inflation.

When We Measure the Impact of Exchange Rate Changes on a Nation's