If a country has a flexible exchange rate system and a deficit on current account
A)the balance of payments must be zero.
B)The balance of payments must be positive.
C)The balance on capital account must be negative.
D)The balance on capital account must be positive.

Question

Quizplus · Accepted Answer

If a country has a flexible exchange rate system and a deficit on current account, it means that the country is importing more goods and services than it is exporting. This would lead to an outflow of its currency, resulting in a depreciation of its exchange rate. This, in turn, makes exports cheaper and imports more expensive, which would eventually reduce the deficit on current account.

However, this depreciation of the exchange rate would also attract foreign investment and lead to an inflow of capital, which would increase the surplus on capital account. Therefore, the balance on capital account must be positive (or in surplus) to maintain the deficit on current account. Thus, option D is the correct choice.

If a Country Has a Flexible Exchange Rate System and a Deficit