ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Depreciation reduces the value of a country’s currency when compared with the currency of other countries. Depreciation discourages imports because the imported goods become more expensive due to a reduction in the value of rupee.As the goods become more and more expensive it leads to rising inflation.

Detailed explanation-2: -Not only do countries with pegged exchange rates have lower inflation on average, they are also associated with lower inflation variability.

Detailed explanation-3: -There is upward pressure brought about by an increase in the demand for the domestic currency due to an increase in demand for exports, this creates an excess demand for the currency as shown below.

Detailed explanation-4: -When inflation is higher, this tends to have a depressing affect on the value of a country’s currency. This is because increased inflation reduces the currency’s buying power, which weakens it against other currencies. The impact of increasing inflation on currency conversion rates is usually downwards.

Detailed explanation-5: -Thus, depreciation of a currency tends to increase a country’s balance of trade (exports minus imports) by improving the competitiveness of domestic goods in foreign markets while making foreign goods less competitive in the domestic market by becoming more expensive.