“If Country A has a large current account deficit relative to Country B, Country A will most likely experience a build-up of its holding of Country B’s, and any attempts to reduce the holding would result in a depreciation in Country A’s currency relative to Country B’s currency.”
Question:
With respect to Statement 3, what mechanism of exchange rate correction is Harnish most likely referring to, and is his statement correct?
Answer:
Harnish is referring to the portfolio balance channel. However, countries with current account surpluses (Country A) will see a buildup of their holdings of deficit nations’ assets (Country B’s). Attempting to reduce these holdings will cause the deficit nations’ currencies to depreciate.
Does this make any sense to you? I don’t see it at all. I see it the other way around. If country A has a large current account deficit relative to B, then we import more of their goods than we export to them. Country B would see its reserve of country A’s currency increase right? Is their a mistake in their answer?