Exam 13: Mechanisms of International Adjustment

Figure 13.2. Australian Economy Under a Fixed Exchange Rate System -Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)₀ intersects (X-M)₀, suppose that increased thriftiness leads to an autonomous increase in Australian saving of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____.

The monetary approach to balance-of-payments adjustments suggests that all payments deficits are the result of:

Under a fixed exchange rate system, adjustment mechanisms work for the automatic return to current-account balance after the initial balance has been disrupted.

The monetary approach contends that, under a fixed exchange rate system, an excess demand for money leads to a trade deficit.

Reliance on an automatic adjustment process tends to be unacceptable in trade-deficit nations since it requires them to accept price deflation and/or falling income as a cost of reducing imports.

That the balance of payments could be adjusted by prices and interest rates, under a fixed exchange rate system, originated with Keynesian theory during the 1930s.

Figure 13.3. U.S. Capital and Financial Account Under a Fixed Exchange Rate System -Refer to Figure 13.3. Falling investment profitability in the United States, relative to investment profitability abroad, would shift the U.S. capital and financial account schedule downward from CA₀ to CA₁, resulting in net financial outflows from the United States.