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Evaluating a Policy to Boost Export Competitiveness
The government of a country with a persistent trade deficit announces a policy to significantly devalue its currency's nominal exchange rate, aiming to make its goods cheaper for foreign buyers and thus more competitive. Critically evaluate the likely success of this policy in achieving its goal. In your answer, explain how other economic factors, as represented in the formula for the relative price of foreign versus domestic goods, could either support or undermine the intended outcome of the currency devaluation.
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Evaluating a Policy to Boost Export Competitiveness
A country's central bank observes that its domestic price level is projected to increase by 8% over the next year, while the price level of its primary trading partner is only expected to increase by 3%. According to the formula for the real exchange rate, which measures the relative price of foreign to domestic goods, what approximate change in the nominal exchange rate would be required to keep the country's international competitiveness stable (i.e., to hold the real exchange rate constant)?