Quiz 33: Common Currency Areas


The United States decided to have a favorable trade balance by promoting exports with zero imports. a.To pay the imports from United States, other countries will buy dollars, which in turn causes capital outflow. Therefore, the favorable trade balance will cause capital account deficit. b.Promoting exports with zero imports will reduce the current per capita consumption. Fall in current per capita consumption will lead to a fall in current standard of living. c.Payments made on export are credited, whereas payments made on imports are debited. Hence, credit will exceed debit, if a country promotes exports with zero imports. d.If all international transactions are considered, that is, both current and capital account, then total credit must be equal to total debit. e.The role of statistical discrepancy in the balance of payments is to adjust the disequilibrium between credits or debits.

Depreciation: Depreciation is a result of shift in demand and supply of a foreign currency. If the demand for foreign currency is more than its supply, then the value of foreign currency will increase. As a result, the value of domestic currency (dollar) will depreciate.Devaluation: Devaluation is a process of reducing the value of domestic currency (dollar) by buying foreign currency. This is done by the central bank of a country. Difference: The difference between depreciation and devaluation is that the depreciation occurs automatically as market moves forward for trading , whereas the devaluation occurs because of the central bank interference.

Arbitrageur Arbitrageur buys a currency from one market where it is quoted at a low price and sells it at another market where it is quoted at a higher price.The value of the currency will increase in the market where arbitrageurs buy and it will fall where arbitrageurs sell. Thus, an arbitrageur helps to maintain the same exchange rate of the currency in markets all over the world.

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