Which of the following must be true under the flexible exchange rate regime:
A) BRA = BKA
B) Export = Import
C) A Current Account deficit (surplus) must be matched by a Capital Account deficit (surplus).
D) A Current Account surplus (deficit) must be matched by a Capital Account deficit (surplus).

Question

Quizplus · Accepted Answer

Under a flexible exchange rate regime, the exchange rate is determined by supply and demand in the foreign exchange market. A country's trade balance, represented by its current account balance, can affect the demand and supply of its currency, which can in turn affect the exchange rate. Therefore, if a country has a current account surplus, there will be an excess supply of its currency in the foreign exchange market, leading to a depreciation of its currency. To prevent this, investors will purchase financial assets or invest in the country, leading to a capital account surplus. Conversely, a current account deficit will lead to an excess demand for the currency, leading to an appreciation, and investors will want to sell financial assets or divest from the country, leading to a capital account deficit. Thus, a current account surplus/deficit must be matched by a capital account deficit/surplus to maintain exchange rate stability. Therefore, choice D is the correct answer.

Which of the Following Must Be True Under the Flexible