A balance of payments crises under fixed exchange rates occurs when
A) marginal returns on foreign exchange investments approach zero.
B) a country runs out of foreign reserves.
C) a country is in a liquidity trap.
D) forward currency markets undergo high volatility.
E) exports and imports expand beyond some point.

Question

Quizplus · Accepted Answer

A balance of payments crisis occurs when a country exhausts its foreign reserves and is unable to meet its external financial obligations. This is a common problem under fixed exchange rates since the government must maintain the exchange rate by buying or selling its own currency in foreign exchange markets, which depletes foreign reserves. Once reserves are depleted, a devaluation or floating of the currency may be necessary to restore balance to the payments system.

A Balance of Payments Crises Under Fixed Exchange Rates Occurs