A change in the exchange rate will affect the relative prices of domestic and foreign produced goods and services.

If a foreign currency depreciates, it is now worth less in our home currency.

Receipt – adverse movement – will receive less in your home currency.

Payment – favourable movement – will end up paying less in your home currency.

Example

Suppose the exchange rate between the US and Japanese currencies is $1 US = 100 yen. But then the dollar falls in value so that $1 = 70 yen. Americans buying a good cost; will now have to pay more dollars.

However, for American firms, their exports will now be more competitive. If a good cost $20, it used to cost a Japanese 2,000 yen. But now, after devaluation, it will cost only 1400 yen.

Therefore, a devaluation of the dollar will lead to an increase in demand for American goods. Furthermore, as the US exports more and reduces imports, it will lead to an improvement in the current account deficit.