If 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?
It is given that –
•Country A has high inflation than country B
•The exchange rate is fixed
In this case there are following possibilities –
•It is advantageous for country B to export goods to country A
•It will be expensive for country A to export goods to country B where as it will be advantageous to import form country B
•So this will give rise to imports of country A and exports of country B
•It will lead to trade surplus in country A and trade deficit in country B
Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).