Each circumstance requires an answer including the \"why or why not\": Can a cou

Question

Each circumstance requires an answer including the "why or why not":

Can a country have a:

a. current-account deficit, capital-account surplus, and flexible exchange rate? Why or why not?

b. current-account deficit, capital-account deficit, and flexible exchange rate? Why or why not?

c. merchandise trade deficit, capital-account deficit, and flexible exchange rate? Why or why not?

d. current-account surplus, capital-account surplus, and fixed exchange rate? Why or why not?

e. current-account surplus, capital-account surplus, official settlements balance surplus, and fixed exchange rate? Why or why not?

Explanation / Answer

The current account deals with the trade of goods between countries. For example, the US imports more than it exports, so it's current account has been in deficit for the past few decades.

The capital account measures monetary flows between countries used to purchase financial assets such as stocks, bonds, real estate and other related items.

The sum of these two accounts usually (and should) equal 0 (zero).

A floating currency changes with supply and demand. A fixed currency is pegged by the government (often against the dollar) to create stability.

With these facts, let's move onto the questions.

a) Current Account Deficit (export more), capital account surplus (other countries buy their currency, bonds, etc). Flexible? NO! With a fixed currency, the investor will always know what his or her investment's value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.

b) Both accounts in deficit... this is not a good situation, the country is importing more goods but no country wants to buy their bonds or wealth. The country should use a fixed currency and lower the price of their goods become cheaper and they export more.

c) See b, same reason.

d) No! A flexible exchange rate is needed to allow for the currency to increase in value.

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