Question

3. What is the importance of the short run capital flow in BOP account
4. How an increase of a country export on goods affect the BOP account?
5. How the fixed exchange rate promotes investment stability?
6. How the flexible exchange rate system isolates domestic economy from external shocks?

Answer 1

The Balance of Payments (BOPs) is the systematic record of all the monetary transactions between one country and its nationals with any other country. The capital account records the flow of goods and services in and out of a country. It involves inward investments, purchase of assets etc. The transactions involving capital flows provides a positive sign to the statement of BOP.

Current account deficit financing. Short term capital inflows from abroad can help in financing a current account deficit. Through attracting capital flows, it enables households to effectively import more goods and services which would restore equilibrium in the BOP.

Increased productive capacity. Inward investments in short term will not only increase AD but also increase AS. Such investments increases productive capacity and hence increases exports and improves equilibrium in BOP.

Advantage of market fluctuations. Capital flows into bank accounts or given as loans also makes it possible for the market to take advantage of fluctuations in interest rate.

2. Increase in export of goods over imports increases the trade balance which increases the current account balance as money flow increases and hence results in positive balance of BOP.