Final answer:
A depreciation of the domestic currency leads to a lower real exchange rate, making domestic goods cheaper for foreign buyers, which can improve demand for these goods and influence the country's trade balance and exchange rate markets.
Step-by-step explanation:
When a domestic currency depreciates and the price levels remain constant, the real exchange rate of domestic goods relative to foreign goods decreases, making domestic goods cheaper in comparison to foreign goods. As a result, we can expect an increase in demand for domestic goods by foreign buyers and a potential improvement in the domestic country's trade balance. The exchange rate influences the international competitiveness of a country's goods and services.
Depreciation of the domestic currency (a fall in E) means that domestic goods become less expensive for foreigners, affecting the exchange rate markets in the short to medium term. Inflation rates play a critical role in this dynamic. Higher inflation in a country can decrease the demand for that country's currency due to its eroding purchasing power, catalyzing a depreciation of the currency. Therefore, a nominal depreciation in currency, absent inflation effects, would make the real exchange rate more favorable for domestic goods in international markets.