Question

Suppose that a country, say Peru, has a growing current account defecit (X-M) is negative and becoming more negative. Also Peru's money (Nuevo Sol) is rising in value relative to the US dollar and domestic investment spending (Id) in Peru is rising. According to our reading, is Peru's current account deficit a "disorder" or not? Explain why (In answering you would likely consider what the exchange rate and investment spending changes imply about the causes of the deficit--and whether the implied cause is a good or bad thing).

Answer 1

In this case what is essentially happening here is that the interest rates in Peru must be very low and this is causing increased investment at home as investment is attractive and so there is increased demand for the Peru currency. This increased demand caused an appreciation of the Peru currency and makes Peru goods more expensive to others. This will cause the current account deficit in Peru to worsen. Thus it is the loose monetary policy in Peru which is encouraging great investment which is good for the growth of the country and so though the current account deficit is worsening, it is for a good cause in that investment at home is rising causing the currency to appreciate.Thus this is not a disorder and so this is not a bad thing.