Deficits and surpluses in the balance of payments are eliminated by ____ in a pure flexible exchange rate system.

Question

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In a pure flexible exchange rate system, the market mechanism will adjust the exchange rate to eliminate deficits or surpluses in the balance of payments. If there is a current account deficit, the exchange rate will depreciate, making exports cheaper and imports more expensive, thus reducing the deficit. If there is a current account surplus, the exchange rate will appreciate, making exports more expensive and imports cheaper, thus reducing the surplus. Financial borrowings, reserve movements, and changes in fiscal and monetary policies may affect the exchange rate and the balance of payments, but in a pure flexible exchange rate system, their impact is secondary to the market mechanism.

Deficits and Surpluses in the Balance of Payments Are Eliminated