4.5.3—Consequences of exchange rate changes

A depreciation raises the domestic price of imports and lowers the foreign-currency price of exports, while an appreciation does the reverse. The effects on the trade balance depend on demand elasticities, domestic capacity and the time allowed for contracts to change.

A cheaper currency can initially worsen the trade balance if import payments rise before quantities respond—the J-curve idea. It can also add cost-push inflation through imported fuel and materials. Do not infer a guaranteed improvement from “more competitive exports.”

A depreciation can shift AD right through higher net exports, raising growth and lowering cyclical unemployment when spare capacity exists, but it can raise demand-pull and imported cost-push inflation. The current account improves only if export and import quantities respond sufficiently and after contract lags; imported goods and foreign travel become less affordable, lowering some living standards. Appreciation reverses these pressures: cheaper imports may lower inflation and improve purchasing power but weaker net exports can reduce growth and employment. Use AD/AS to show the initial context rather than claiming a fixed outcome.