Question

Suppose that the inflation is higher in country A than in country B, and the exchange rate between the two countries is fixed. What is likely to happen to the trade balance between the two countries?

Answer 1

The exchange rate is one of the most important determinants of competitiveness of a country. It plays a vital role in the country's level of trade. As per the above condition, it is favourable for country A to import goods and on the other hand for country B export is favourable.

There would be no balance in trade between the two countries as country A is importing more goods as compared to exports which results in a trade deficit and on the other hand, country B suffers from trade surplus because they are focusing more on exports than imports.