Suppose that a country which is a major world producer of food and feed grains experiences fabulous weather and a bumper crop. Its current account balance will necessarily increase and its real exchange rate will necessarily depreciate.
True or False?
The correct answer is False. The bumper crop yields a temporary increase in income which will be saved to provide capital that can be drawn down in years when the crop is very poor. Savings will increase and the SI line will shift to the right. At the same time, the better than average crop will result in higher than average exports, shifting the CB curve to the right. The effect on the real exchange rate will depend upon which curve shifts furthest to the right. The current account balance will necessarily increase but the real exchange rate could either appreciate or depreciate, depending upon whether savings increases more or less than exports. If all the increased income resulting from the increased exports is saved, the real exchange rate will not change.