Question

The devaluation of currency would normally eliminate a deficit on the current account of the balance of payments in countries with a flexible exchange rate system. But this is not always the case. Could you explain why it might not happen always? thank you for answer in advance

Answer 1

Answer - After the devaluation , the domestic currency becomes cheaper for the foreigners. For them , the products of country become cheaper. Hence our exports increase and imports decrease leading to the reduction in the deficit of the current account. But on the other side , the interest rate will fall , leading to less attractive investments. The crowding out effect may reduce the exports because of expensive cost of borrowing. Hence this may not always be beneficial.