Question

Use a 2-bloc model to explain in words how can be constant inflation in each bloc but current account imbalances?

Answer 1

In 2 bloc model let there be two blocs namely A and B representation of countries. Constant inflation in both blocs will certainly lead to increased interest rates by central banks in both the blocs.

Now if interest rate is higher in bloc A than Bloc B, the currency will apprrciate and hence net imports will br greater than exports and causing trade deficit .

On same hand the appreciation of currency in bloc A will lead to depreciation of currency in bloc B. As result thr net exports will be more than net imports in bloc A and consequently the trade surplus will arise.

Thus we can conclude that constant inflation in both blocs causes trade imbalances.