Under a System of Fixed Exchange Rates: Factors Contributing to Balance of Payments Deficit

Factors Contributing to Balance of Payments Deficit

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Question

Under a system of fixed exchange rates, which of the following will most likely increase a balance of payments deficit?

Answers

A. an increase in foreign-aid grants

B. an increase in foreign-aid grants and expansionary monetary policy, which will drive prices up and interest rates down

C. expansionary monetary policy, which will drive prices up and interest rates down

D. a reduction in income from investments abroad

E. restrictive monetary policy, which will keep prices down and interest rates up C

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Explanations

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A. B. C. D. E.

Explanation

Expansionary monetary policy will create inflation and cause interest rates to fall. Both of these consequences will cause the demand for U.S. exports and assets to fall which will increase the balance of payments deficit.

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