Under a flexible exchange rate system, a nation that offers more attractive investment opportunities than its trading partners will be likely to experience a: A) surplus on current account transactions. B) deficit on its capital account transactions. C) deficit on current account transactions.
C attractive investment opportunities = higher demand for domestic currency = Currency appreciation = lower exports = Current account deficit
haha, very good
$tarving_Banker, what if the options were like this? A) surplus on current account transactions. B) Surplus on its capital account transactions. C) deficit on current account transactions.
In that case, I think both B & C will make sense, they are essentially describing the same condition In a pure floating exchange system Current account deficit = Financial account surplus
Which one will be more correct short term?
no clue. Does time horizon matter in this question? How would you approach it?
but another way is also to remember that Current + Capital plus official reserv=0. if current is in deficit the capital will be surplus. my reasoning was if ivestmen opportuniies rae good the capital account will be surplus to balance the equestion the Current must be deficit. so C
My reasoning on this is that with more attractive investment opportunities, foreigners will be buying U.S. investments (stocks, bonds, CD’s, etc). This results in a capita/financiall account surplus more quickly than any deficit in teh curent account, which gets affected less quickly (remember prices are sticky).
BOP identity: exports + capital inflows = imports + capital outflows C) deficit on current account transactions.
like what Audrey said, current acct + financial acct = 0 (there is not reserve since it’s a floating system) This equation must hold at all time since it describes the supply and demand of the domestic currency. When financial acct goes up, there must be an equal decrease in current acct at the same time. For example, when foreigners want to invest $50B the U.S. (financial acct surplus for U.S.) they first need to have US dollar of $50B. And the only way to get that $50B is to sell $50B worth of goods (current acct deficit, from the US perspective) to the U.S.
> current acct + financial acct = 0 (there is not reserve since it’s a floating system) current acct + financial acct + official reserves = 0. Official reserve is not related to floating system. For example, the U.S. has a floating system, and it always has a positive or negative reserve.
A pure floating system, the government does not attempt to set the exchange rate, therefore there is no need for the official account. But I guess in real life, they do try to intervene from time to time. And that is why you end up with some reserve. Nevertheless, I don’t think we need to go into that much detail to answer the question at hand.