If a country with a fixed exchange rate faces a fundamental disequilibrium because it has a large, ongoing surplus in it official settlements balance, which of the following policies can it employ to try to achieve external balance?

Question

Quizplus · Accepted Answer

If the country has a fixed exchange rate, it cannot adjust its exchange rate to achieve external balance. Imposing import barriers could reduce imports and improve the balance of trade, but it would also reduce exports and potentially harm economic growth. Raising interest rates could attract foreign investment and reduce the surplus in the official settlements balance, but it could also harm domestic investment and consumption. Obtaining a loan from the IMF would provide temporary relief, but it would not address the underlying balance of payments problem. Allowing the exchange rate to float would allow the market to determine the exchange rate, which could result in a depreciation of the currency, making exports more competitive and reducing the surplus in the official settlements balance. Therefore, the best choice is C.

If a Country with a Fixed Exchange Rate Faces a Fundamental