Question

As the value of the US dollar rises, what is likely to happen to the US balance of payment on current account? Explain.

Answer 1

As the value of the US dollar rises, what is likely to happen to the US balance of payment on current account? Explain?

Ans): As the dollar rises in value, other things being equal, U.S. goods and services become relatively more expensive in foreign currency terms, while foreign goods and services become relatively less expensive in dollar terms. The result is a smaller surplus or larger deficit on the current account.

Of course, this conclusion could be reversed if the reason for the rise in the real value of the dollar was a significant increase in U.S. productivity, which would facilitate exports. However, other things do not remain equal. In fact, exchange rates equate currency supplies and demands. They do not determine the distribution of these currency flows between trade flows (i.e the current-account balance) and capital flows (i.e the financial-account balance). This view of exchange rates predicts that there is no simple relation between the exchange rate and the current-account balance. Trade deficits do not cause currency depreciation, nor does currency depreciation by itself help reduce a trade deficit: Both exchange rate changes and trade balances are determined by more fundamental economic factors. These more fundamental factors are a nation’s savings and investment decisions.