Question

what kind of monetary policy can central banks carry out in the case of deficits in capital account balance? Explain in detail how it affect the balance of payment.

Answer 1

ANS; Central bank or Reserve bank or Monetary authority is an institution that manages the currency, money supplies, interest rates etc across the banking system.

Capital account is a record of inflows & outflows of capital that directly affects the nation's foreign assets & liabilities & also includes the repatriation of Foreign exchange.Capital account deficit occurs when equity in a business turns negative.

Central Bank uses three tools of monetary policy. They are :-

• Open Market Operation
• Discount rate
• Reserve Requirement

1. Open Market Operation refers when the Federal reserve purchases & sells U.S Treasury securities in the Open market.This Policy helps in maximising employment, brings stablility in prices etc.
2. Discount rate policy taken by the central bank to control the money circulation by increasing or decreasing the interest rates.
3. Reserve Requirement is also called as cash Reserve ratio; through this central bank sets the minimum amount of reserve that a commercial bank must hold.

Balance of payments (BOP) is a statement of all transaction made between entities of one country & the rest ofthe world over a specified period of time. central bank with the help of monetary policy respond to the increase in prices with least growth in money in form of interest rate on saving & fixed deposit & vice-versa in case of decrease in prices.