Question

If a country has a “twin surplus” (current account surplus and fiscal surplus), it is likely to have:

A) An undervalued currency

B) A low level of government investment relative to government consumption (G)

C) A low level of private investment relative to private consumption (C)

D) All of the above

E) None of the above

Answer 1

Option A

It can be attributed to one cause: the inflexibility of country's exchange rate regime. The existence of twin surpluses, by definition, means that the currency is undervalued. If the currency were allowed to appreciate to reach an equilibrium level, regardless of which particular channels, the current account and capital account would have to sum to zero. This implies that country must be running a current account surplus and capital account deficit, or a current account deficit and capital account surplus, unless by chance both accounts happen to be in balance.