Currency depreciation always leads to an improvement in the trade balance.

Question

Consider the following statements:

Assertion (A): Currency depreciation always leads to an improvement in the trade balance.

Reason (R): The real exchange rate adjusts the nominal exchange rate for differences in price levels (inflation) between countries.

Select the correct answer:

1. A. Both A and R are true, and R is the correct explanation of A
2. B. Both A and R are true, but R is not the correct explanation of A (Correct answer)
3. C. A is true, but R is false
4. D. A is false, but R is true

Correct Answer

Option B — Both A and R are true, but R is not the correct explanation of A

Detailed Solution & Explanation

The correct answer is Both A and R are true, but R is not the correct explanation of A.

Key Points

• Currency depreciation does not always improve trade balance — the Marshall-Lerner condition must be satisfied, and the J-curve effect means short-run deterioration is common.
• Assertion (A) is therefore too absolute to be true.
• Reason (R) correctly defines real exchange rate.
• Both are true but R does not explain why A holds (or fails).