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Krugman states the following:

Suppose the world economy is in equilibrium. Suddenly the dollar depreciates for some reason. Almost all economists would agree that long run effect would be some combination of inflation in the US and deflation abroad, with original real exchange rate eventually restored and no long run effect on external balances.

I have the following questions:

  1. what does equilibrium mean in context of world economy?

  2. how would real exchange rate be restored?

  3. Why no long run effect on external balances (i suppose this means trade deficit?)

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