Question

Explain how exchange rates may correct a balance of trade deficit?

You attend a alumni event in Santiago Chile and you meet the Governor of the central bank. The governor tells you that the country experiences “deficits in the capital account of the Balance of Payments.” Based on this statement, what do you infer about the Peruvian economy?

What is a put on the USD? How do firms use a put option?

Answer 1

Answer 1:

Exchange rates can be used to correct the balance of trade deficit. Trade deficit occurs when value of imports exceeds value of exports. Thus, the best way to correct trade deficit is depreciation of currency. Depreciation of currency makes the exports of the country cheaper and thus increase demand for exports. On the other hand, depreciation of currency makes imports of the country costlier and thus reduces demand for imports and thus increases the trade balance and reduce the trade deficit of the country. Thus, depreciation of exchange rates can help in correcting balance of trade deficit of the country.