Question 1

With fixed exchange rates, central banks must finance trade deficits, allow a devaluation, or else use trade restrictions to restore equilibrium.

Accepted Answer

Fixed exchange rates mean that the value of a country's currency is fixed to another currency or a basket of currencies. In this scenario, if a country has a trade deficit (importing more than it exports), it means there is an excess supply of its currency in the market, which can lead to a depreciation of its currency. To maintain the fixed exchange rate, the central bank must step in and purchase the excess supply of the currency, often by selling its foreign reserves. This can lead to a drain on the central bank's foreign reserves, and if it cannot continue doing so, it may have to allow a devaluation or implement trade restrictions to restore equilibrium.

Question 2

The U.S. is the world's largest creditor.

Accepted Answer

The U.S. is actually the world's largest debtor, with a national debt of over $28 trillion as of 2021.

Question 3

In the mid 1980s, the massive current account deficits were related to massive U.S. government budget deficits.

Accepted Answer

The massive current account deficits in the mid 1980s were indeed related to massive U.S. government budget deficits. The government was borrowing heavily to finance its spending, which led to a larger supply of dollars in the economy and a lower demand for them, which in turn led to a weaker dollar and larger trade deficits.

Question 4

In international finance, what does SDR stand for?
A) Special Drawing Rights.
B) Single Deposit Reserve.
C) Savings Deposit Ratio.
D) Single Demand Remittance.

Accepted Answer

SDR stands for Special Drawing Rights, which is a type of international reserve asset created by the International Monetary Fund (IMF). It's used as a supplementary foreign exchange reserve and can be used by IMF member countries for various purposes such as settling international transactions or bailing-out member countries in financial crisis.

Question 5

With flexible exchange rates, central banks do not have to finance deficits because BOP equilibrium is restored by changes in exchange rates.

Accepted Answer

With flexible exchange rates, any imbalance in the balance of payments will be reflected in changes in exchange rates. For example, if a country is experiencing a current account deficit, the demand for its currency will fall and its exchange rate will depreciate. This, in turn, will make its exports cheaper and imports more expensive, eventually restoring balance in the balance of payments without the need for central banks to finance deficits.

Question 6

National saving minus investment equals the current account.

Accepted Answer

This is known as the savings-investment identity in macroeconomics. The current account is the difference between a country's exports and imports, as well as any net income and transfers.

Question 7

International Reserve assets are comprised of gold, foreign exchange, and IMF special drawing rights.

Accepted Answer

International Reserve assets are indeed comprised of gold, foreign exchange, and IMF special drawing rights. These assets are held by central banks and other monetary authorities to support their currencies and to provide a source of liquidity in case of economic stresses or international financial crisis.

Question 8

It is possible for each nation to have BOP surpluses.

Accepted Answer

The Balance of Payments (BOP) is a zero-sum game globally; one nation's surplus is another's deficit.

Question 9

Because of the limited usefulness of both the basic balance and the liquidity balance accounts, these two accounts are omitted in the official BOP table.

Accepted Answer

The basic balance and liquidity balance accounts are not typically included in the official Balance of Payments (BOP) table because they are not standard components of the BOP framework, which focuses on the current account, capital account, and financial account.

Question 10

The Balance of Payments always balances.

Accepted Answer

The Balance of Payments is a record of all financial transactions between a country's residents and the rest of the world. It is designed to always balance, meaning that total debits equal total credits. Therefore, the statement is true.

Question 11

Large current account deficits imply large financial account surpluses.

Accepted Answer

A current account deficit means a country is importing more goods and services than it is exporting, which requires financing from other countries. This is typically funded by the financial account, which involves inflows of foreign investment and borrowing. Therefore, a large current account deficit will typically lead to a large financial account surplus.

Question 12

The United States finances current account deficits largely with dollars and, as a result, faces almost no constraint on its ability to run deficits.

Accepted Answer

This is because the US dollar is the world's dominant reserve currency, which means that other countries hold large amounts of US dollars as a means of international exchange and investment. This allows the US to continue to borrow and run deficits without facing significant pressure from lenders to curtail its spending. However, excessive deficits could lead to inflation and a devaluation of the dollar over time.

Question 13

International free trade always hurts the nations that run deficits, and benefits the nations that run surpluses.

Accepted Answer

International free trade can benefit both deficit and surplus nations through increased efficiency, access to a broader range of goods and services, and potential for economic growth. Deficit nations can access necessary imports at lower costs, while surplus nations can expand their markets and production.

Question 14

Define the official settlements balance. Is there any difference between the United States and other countries in terms of what this balance measures? How does this affect the ability of the countries to run current account deficits?

Accepted Answer

The answer of Define the official settlements balance. Is there...

Question 15

The current account can be defined as exports plus imports.

Accepted Answer

The current account is a broader measure that includes not only exports and imports, but also net income from abroad and net unilateral transfers.

Question 16

In basic terms, the current account is equal to
A) imports plus exports.
B) savings minus consumption.
C) exports minus imports.
D) savings plus exports.

Accepted Answer

The current account measures a country's international transactions involving trade in goods and services (exports and imports), income from foreign investments, and unilateral transfers (such as foreign aid). Therefore, the correct formula for the current account is exports minus imports.

Question 17

How are the current account and the financial account related?

Accepted Answer

The answer of How are the current account and the...

Question 18

The United States became a net international debtor in 1985 for the first time since World War I.

Accepted Answer

This is true. The United States became a net international debtor in 1985 due to a large trade deficit and increased borrowing from foreign countries. It remained a net debtor throughout the following decades.

Question 19

If a country has a large deficit in its current account
A) it has a large surplus in its financial account.
B) it exports more than it imports.
C) it is a net creditor to the rest of the world.
D) None of the above are necessarily true.

Accepted Answer

The answer of If a country has a large deficit...

Question 20

If domestic saving exceeds investment, there will be a current account surplus.

Accepted Answer

When domestic saving exceeds investment, it means that there is surplus savings available in the economy. This surplus savings can be used to invest in foreign countries, leading to an increase in exports and a decrease in imports, resulting in a current account surplus.

Quiz 12: The Balance of Payments