Trade Barriers Reduce Demand for Partner's Currency

Steps:

• A fall in country X's exchange rate means depreciation of X's currency against Y's.
• As trade partners, increased trade barriers in Y restrict imports from X.
• Restricted imports decrease demand for X's currency to pay for those goods.
• Lower demand causes X's currency to depreciate.

Why D is correct:

• Trade barriers in Y, per the balance of payments, reduce net exports for X by curbing imports, directly lowering demand for X's currency and causing depreciation.

Why the others are wrong:

• A: Economic growth in Y boosts demand for imports from X, increasing demand for X's currency and appreciating it.
• B: Higher inflation in Y makes Y's goods costlier, shifting demand to X's imports and appreciating X's currency.
• C: Increased money supply in Y depreciates Y's currency via quantity theory of money, relatively appreciating X's currency.

Final answer: D