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You are expected to explain/analyze (AO2) the relationship between the current and financial accounts and the exchange rate (HL), and draw (AO4) a diagram showing the balance between the current account and the exchange rate (HL)
Current Account and Exchange Rate (AO2, AO4) (HL)
Current Account and Exchange Rate (AO2, AO4) (HL)
The current account should technically be balanced by the exchange rate. The following diagram and cycle explains why:
In other words, a deficit will make the currency depreciate, causing more exports, causing a surplus, causing the currency to appreciate, causing a deficit again, and so on.
However, this does not happen in fixed exchange rates, as the currency will neither appreciate nor depreciate. Instead, the government can choose to devalue its currency, increasing exports and reducing imports, and hence maintain a current account surplus.
Financial Account and Exchange Rate (AO2) (HL)
Financial Account and Exchange Rate (AO2) (HL)
A financial account surplus is usually caused by investment in the economy from other countries
This means more local currency will be demanded, appreciating it relative to others
(The value of the local currency will increase in comparison to other currencies)
A financial account deficit is usually caused by investment being pulled out of the economy
This means more local currency is sold, increasing supply, depreciating it relative to others
(The value of the local currency will decrease in comparison to other currencies)
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