Question

How does the balance of payments adjust with a fixed exchange rate?

How does the balance of payments adjust with a flexible exchange rate?

Answer 1

A. In the fixed exchange rate system, the exchange rate is already fixed in respect to moment with various currency and these fixed exchange rates are continuously affecting the balance of payment because when there will be an excess of demand of foreign currency at private foreign Exchange reserves, then it will lead to a balance of payment deficit and when there will be selling of domestic currency and buying of the foreign currency by the central bank, it would be leading to a balance of payment surplus so Central Bank could be trying to manage with the balance of payments surpluses and deficits.

B. Balance of payment is also fluctuating in respect to the flexible exchange rate system in which there will be a free movement of currencies by proper interactions of buyers and sellers who will be continuously driving the currency exchange rate and there would be a fair transparency so balance of payment would be impacted by current accounts and the capital account to large extent and Central Bank will also trying to intervene by buying and selling into the foreign Markets and it will be trying to impact the overall movement of currency by buying and selling currencies and these will be sterilized interventions in order to deal with the fluctuation in the balance of payment.