Current Account Imbalances and the Determination of Exchange Rates
If a country has interest payments on sovereign bonds that are becoming difficult to service, then the currency of that nation is expected to depreciate due to which channel of current account trends?
Incorrect.
The portfolio balance channel is the active decisions by policymakers to reduce asset holdings in certain currencies due to overinvestment, not due to concerns of solvency.
Correct!
That nation presumably ran current account deficits for many years, accumulating debt levels that are now proving to be unsustainable. This tipping point will cause investors to shy away from that currency, causing depreciation through the debt sustainability channel.
Incorrect.
This channel is related to current account imbalances that persist for some time, but which are not necessarily related to debt servicing.
The portfolio balance channel
The debt sustainability channel
The flow supply/demand channel
