ACCA Applied Knowledge · Business and Technology · Macroeconomic factors
A country runs a large and persistent deficit on the current account of its balance of payments. Which of the following is the most likely consequence under a freely floating exchange rate system?
A persistent current account deficit tends to push a floating currency down. Imports require buyers to sell domestic currency for foreign currency, and this exceeds foreign demand for the domestic currency generated by exports, so the exchange rate falls until the market rebalances.
- ADownward pressure on the currency's value because demand for foreign currency exceeds foreign demand for the domestic currencyCorrect
- BUpward pressure on the currency's value because imports exceed exports
- CAutomatic increase in the government's foreign reserves
- DA fixed rate being enforced by the central bank
Explanation
A current account deficit means more domestic currency is being supplied to buy foreign currency for imports than is demanded by foreign buyers of exports. Under a floating rate this pushes the currency down. Option B reverses the logic; reserves are only relevant under managed or fixed regimes.
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