Skip to content

IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates

Under a floating exchange rate with no central bank intervention, a country has a current account deficit. Foreign investors then become more eager to buy its bonds, so the financial account inflow rises. What is the most likely effect?

The currency would most likely appreciate, since foreign demand for its bonds raises demand for the currency. The stronger currency makes exports dearer and imports cheaper, widening the current account deficit, which is consistent with the larger financial account inflow.

  1. AThe currency depreciates until the current account deficit disappears
  2. BThe currency appreciates, which tends to widen the current account deficit furtherCorrect
  3. CReserves fall by the amount of the deficit
  4. DThe current account moves to surplus immediately
  5. There is no effect on the exchange rate because the accounts always balance

Explanation

Greater demand for the country's bonds raises demand for its currency, causing appreciation. A stronger currency makes exports dearer and imports cheaper, so the current account deficit tends to widen, matching the larger financial inflow. Depreciation would be the effect of weaker capital inflow.

Did you get it right without looking?

One question tells you little. A timed set on Balance of payments and exchange rates shows your real accuracy, how long you take and where you lose marks.

Practise Balance of payments and exchange ratesFree diagnostic mock

More Balance of payments and exchange rates questions