If a country is experiencing chronic deficits on current account, what must ultimatelyhappen to its exchange rate?
A) it must appreciate
B) it must depreciate
C) the market will shift it from floating to fixed
D) it pursues lower interest rates than those in other countries
E) it will become equalized, that is, the same rate as in other countries

Question

Quizplus · Accepted Answer

A chronic deficit on the current account indicates that a country is importing more than it is exporting, leading to an outflow of domestic currency to pay for these imports. Over time, this will increase the supply of the domestic currency on the foreign exchange market, putting downward pressure on its value. Therefore, the exchange rate of the domestic currency must depreciate to correct the imbalance by making exports cheaper and imports more expensive, thereby encouraging a move towards a more balanced current account.

If a Country Is Experiencing Chronic Deficits on Current Account