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? Justify your answer.

If inflation is higher in country ‘A’ than in country ‘B’ and

1.	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? Justify your answer.
Answer» When there is inflation, the domestic currency of country A’ will depreciate. Depreciation of domestic currency will lead to increase in export and decrease in import. But this will depend on the elasticity of export and import. If the sum of export and import elasticities is greater than T, there will be positive effect on trade balance. However, in short run the elasticities are supposed to be less than T and therefore there may be negative effect on trade balance. The ultimate effect depends on the composition of trade items.