In a large open economy, the exchange rate adjusts so that net exports equal:
A) domestic saving.
B) domestic investment.
C) net capital outflow.
D) domestic investment plus net capital outflow.

Question

Quizplus · Accepted Answer

In a large open economy, the exchange rate adjusts so that net exports equal net capital outflow. This is known as the balance of payments equilibrium condition. When net exports are positive, there is a net inflow of foreign currency, which creates a demand for domestic currency, causing the currency to appreciate. Conversely, when net exports are negative, there is a net outflow of domestic currency, which creates a supply of domestic currency, causing the currency to depreciate. Therefore, the correct answer is C, net capital outflow.

In a Large Open Economy, the Exchange Rate Adjusts So