Question

A country with a balance of payments deficit that wants to maintain the current exchange rate:

A. gains official reserves. B. loses official reserves. C. gains foreign liabilities. D. loses foreign assets.

Answer 1

Balance of payment deficit is a situation in which imports of goods, services, investment income and transfers exceed the exports of goods, services, investment income and transfers . The balance of payments does not impact the exchange rate in a fixed-rate system because central banks adjust currency flows to offset the international exchange of funds .

A balance of payments deficit arises whenever there is excess demand for foreign currency on the private FOREX at the official fixed exchange rate . To satisfy the excess demand the central bank will typically automatically intervene on the FOREX and sell foreign reserves . Thus, by tracking sales of foreign reserves in the official reserve account we can determine if the country has a balance of payments deficit or not . So answer is : D. loses foreign assets.