A country's currency depreciates in value on the foreign exchange market. This is most likely to contribute to
Question 1 Report
A country's currency depreciates in value on the foreign exchange market. This is most likely to contribute to
Answer Details
The correct answer is imported inflation because the cost of foreign goods rises.
When a country's currency depreciates (falls in value on the foreign exchange market), it takes more domestic currency to buy one unit of foreign currency. This has direct consequences for import prices:
- Imported goods become more expensive in domestic currency terms. For example, if the currency falls by 20%, an import that cost $100 now costs the equivalent of $120 in domestic currency.
- Higher import prices feed through to consumer prices (imported consumer goods) and production costs (imported raw materials and components).
This type of inflation is called imported inflation because the price increases originate from changes in the exchange rate affecting import costs.
Exports actually become cheaper in foreign currency terms (not more expensive). Production costs for domestic firms that use imported inputs will rise, not fall. The general price level is pushed upward, not downward.
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