Explain the relationship between the Current Account and Capital Account Balances with a floating exchange rate. How does the Exchange Rate function to ensure this relationship holds (assuming no changes in the Official Settlements Balance)? How does this change if we’re talking about a Fixed Exchange Rate and we relax this assumption?

Explain the relationship between the Current Account and Capital Account Balances with a floating exchange rate. How does the Exchange Rate function to ensure this relationship holds (assuming no changes in the Official Settlements Balance)? How does this change if we’re talking about a Fixed Exchange Rate and we relax this assumption?

 

 

Answer:

Current Account deals with trade of goods and services between two countries where Capital Account deals with monetary flows between countries in share or stock or in any investment.In a floating exchange rate both current account and capital account balance can change according to the value of the currency of that currency, which is decided freely by market using demand and supply of that currency.If someone not from USA holds $ in any investment and value of $ increases than the worth of that person will be increased.

The exchange rate market is not fixed or constant so value will change according to the performance of the currencies that are used.It generally gives the true picture and value of trade and investment.

In Fixed exchange rate generally value of currency is fixed by the respective central bank so the balance does not change. Value of currency does not fluctuate and due to this current account and capital account balance decided by the volume of trade and investment. Fluctuation is rare in case of fixed exchange rate.

Asked on February 15, 2018 in economics.
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