Question

1) Is it possible for a country to have, simultaneously, a current account deficit along with a balance of payments surplus? Explain your answer with reference to the significance and meaning of each of the BOP accounts. Be sure to discuss the possible implications for official international reserve flows (i.e. the reserve portion of the financial account).


2) Explain the interest parity condition and how it can be used to determine the equilibrium exchange rate. A full verbal and graphical discussion is needed.

Answer 1

1) It is possible for a country to have, simultaneously, a current account deficit along with a balance of payments surplus, if this country imports more than exports, but receives more foreign investment than invests in other countries.
2) Interest rate parity is a theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate. Interest rate parity plays an essential role in foreign exchange markets, connecting interest rates, spot exchange rates and foreign exchange rates.