Country Z has a fixed exchange rate policy and its own currency. Country Z experienced an inflation rate of 27% in the past year, whereas a weighted price index for its trading partners has only risen by a rate of 3%. In the previous year, country Z had a relatively balanced current account. The Central Bank of Country Z decided to devalue its nominal exchange rate by 20%. Assuming that Country Z experienced no significant external shocks during the year and did not introduce any changes in its trade policies, will country Z’s exchange rate be overvalued or undervalued this year after this nominal devaluation? Will that lead the current account balance to change? In which direction is it likely to change?
Country Z has a fixed exchange rate policy and its own currency. Country Z experienced an inflation rate of 27% in the past year, whereas a weighted price index for its trading partners has only risen by a rate of 3%. In the previous year, country Z had a relatively balanced current account. The Central Bank of Country Z decided to devalue its nominal exchange rate by 20%. Assuming that Country Z experienced no significant external shocks during the year and did not introduce any changes in its trade policies, will country Z’s exchange rate be overvalued or undervalued this year after this nominal devaluation? Will that lead the current account balance to change? In which direction is it likely to change?
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