Question text 2Marks Assume Country A's external wealth is positive, with all external liabilities and assets denominated in euros (foreign currency). Suppose that Country A's currency (dollar, A$) depreciates against the euro, an increase in E(A$/euro). Then, this depreciation Answer 10[select: , does not change, increases, decreases] the external wealth of Country A in A$.Notes Report question issue Question 8 Notes

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BlackTom AI · Accepted Answer

The question concerns how the depreciation of Country A's currency (A$) against the euro affects Country A's external wealth, given external wealth is denominated in euros and all values are expressed in euros and A$. Since the currency depreciation is defined as an increase in the price of euros in terms of A$ (E(A$/euro) rises), each euro is now worth more A$ than before.

Step-by-step reasoning:
- External wealth is denominated in euros, so its value in euros is fixed by assets and liabilities in euro terms.
- To express that euro-denominated wealth in Country A's currency (A$), we multiply the euro value by the exchange rate E(A$/euro).
- When A$ depreciates against the euro, E(A$/euro) increases, meaning more A$ are required to purchase one euro.
- Consequently, the euro-denominated wealth, when converted to A$, becomes larger in A$ terms because the euro amount is multiplied by a higher A$ per euro rate.
- Therefore, the external wealth expressed in A$ rises as a result of the depreciation.

Why this is not a decrease or no change:
- A depreciation of A$ does not reduce the euro-denominated wealth in A$ terms; it increases it, because each euro buys more A$ now.
- The only way external wealth in A$ would decrease would be if the A$ depreciation had a reverse effect or if the wealth were measured exclusively in euros without conversion, which is not the case here since we are asked about the external wealth in A$ terms.

In sum, the depreciation of A$ against the euro raises the A$ value of euro-denominated external wealth, so the correct implication is that external wealth in A$ increases.

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