Countries occasionally intentionally devalue their currencies. So what is the logic and likely results of intentionally devaluing their domestic currency?

Question

International economic analysis characterizes the trade balance adjustment process as occurring in three stages. List and explain the three stages too.
What will be an ideal response?

Answer 1

Answer: International economic analysis characterizes the trade balance adjustment process as occurring in three stages: 1) the currency contract period; 2) the pass-through period; and 3) the quantity adjustment period. Assuming that the trade balance is already in deficit prior to the devaluation, a devaluation at time results initially in a further deterioration in the trade balance before an eventual improvement. The path of adjustment, as shown, takes on the shape of a flattened "j."
In the currency contract period, a sudden unexpected devaluation of the domestic currency will deteriorate the trade balance simply because all the contracts for exports and imports are already in effect. Firms operating under these agreements are required to fulfill their obligations, regardless of whether they profit or suffer losses. In the pass-through period, as exchange rates change, importers and exporters eventually must pass these exchange rate changes through to their own product prices. Import prices rise and export prices are now cheaper compared to foreign competitors' because the dollar is cheaper. The third and final period, the quantity adjustment period, achieves the balance of trade adjustment that is expected from a domestic currency devaluation or depreciation. As the import and export prices change as a result of the pass-through period, consumers both in the United States and in the U.S. export markets adjust their demands to the new prices. Imports are relatively more expensive; therefore the quantity demanded decreases. Exports are relatively cheaper; therefore the quantity demanded increases. The balance of trade — the expenditures on exports less the expenditures on imports — improves.