Trade imbalances affect exchange rate movements from "summary" of International Money and Finance by Michael Melvin
Trade imbalances between countries can have a significant impact on exchange rate movements. When one country consistently exports more goods and services than it imports, it creates a surplus in its trade balance. This surplus leads to an excess supply of the country's currency in the foreign exchange market. As a result, the value of the country's currency is likely to decrease relative to other currencies. This depreciation makes the country's exports cheaper for foreign buyers, which can help reduce the trade imbalance over time. Conversely, when a country imports more than it exports, it creates a trade deficit. This deficit results in an excess demand for the country's currency in the foreign exchange market. As a consequence, the value of the country's currency is likely to appreciate against other currencies. This appreciation makes imports more expensive for domestic consumers, which can help narrow the trade imbalance over time. The relationship between trade imbalances and exchange rate movements is not one-way. Exchange rate movements can also influence trade imbalances. For example, a depreciation in a country's currency can make its exports more competitive in the global market, leading to an increase in exports and a reduction in the trade deficit. On the other hand, an appreciation in a country's currency can make imports cheaper, leading to an increase in imports and a widening of the trade deficit.- Trade imbalances and exchange rate movements are closely intertwined. Changes in trade balances can lead to fluctuations in exchange rates, and vice versa. Policymakers and market participants need to carefully monitor these dynamics to understand how trade imbalances and exchange rate movements can impact a country's economy. By recognizing the interconnected nature of these factors, they can make informed decisions to promote a more balanced and sustainable international trade environment.
