Answer to Question #293379 in Macroeconomics for Ali

Question

what are the effects of the deficits and debt on the stability of exchange rates?

Answer 1

Effects of Deficits and debt on Exchange Rates

While public debt can be said to stimulate the economy of a domestic country, large amounts of it is detrimental to foreign exchange rates. When debts are high enough, repayment means withdrawal of the domestic currency to the outside world, in large enough quantities, and at a cheaper value. This in turn leads to the outside world having more of the domestic currency, or the domestic nation lacking much of the foreign currency reserves. Either way, the domestic currency appears devalued, lowering the exchange rates of the nation. On the other hand, a deficit in the balance of payments, indicates that the domestic nation has used more of its foreign currency reserves in the performance of trade. This leads to the conclusion that a deficit will lower the foreign exchange rate of the domestic country as its supply exceeds demand. (Kouladoum, 2018)

Reference.

Kouladoum, J. C. (2018). External debts and real exchange rates in developing countries: evidence from Chad. https://mpra.ub.uni-muenchen.de/id/eprint/88440