Question

In: Economics

Suppose you have the following balance of payment account balances for a country (in millions of...

Suppose you have the following balance of payment account balances for a country (in millions of dollars)

Year 1 2 3 4 5

CA 85 95 115 125 150

FA -100 -105 -110 -115 -125

For each year calculate the country’s official reserve (OR) account balance and very briefly (in one sentence) describe the expected behavior of the real value of its currency over the five-year period.

Expert Solution

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Question:

Answer:

Country’s official reserve (OR) account balance:

This is a part of capital account, in which the central bank held the foreign currencies and securities to manage the BOP year to year. When trade account is in deficit then OR is negative and vice-versa. It is equal to the difference between capital account and current account. A positive OR is favorable for the nation and vice-versa. BOP is equal to CA + FA - RO =0.

Country’s official reserve (OR) account balance for year 1 =

BOP = CA + FA - RO = 0

= 85 + (-100) - RO = 0

RO = -15

Country’s official reserve (OR) account balance for year 2 =

90 + (-105) - R0 =0

RO = -5

Country’s official reserve (OR) account balance for year 3 =

115 + (-110) - R0 =0

OR = 5

Country’s official reserve (OR) account balance for year 4 =

125 + (-115) - R0 =0

OR = 10

Country’s official reserve (OR) account balance for year 5 =

150 + (-125) - R0 =0

OR = 25

In the first two years import is higher than export and in last 3 years export is higher than import. When export is more than its make the net capital outflow positive and its increase the reserve of foreign currency and assets. Other side higher export also increase the demand for foreign currency that appreciate the domestic currency. Lower export than import means negative net export or current account deficit that make the net capital outflow negative and and depreciate the domestic currency and vice-versa.When the balance of payments is in deficit, the country will have a weak exchange rate and vice-versa because of negative net capital outflow.

Real value of currency is the inflation adjusted value. When currency get appreciated then its increase the purchasing power of the currency . Increasing purchasing power of the currency means decreasing inflation level. When currency depreciate then its decrease the purchasing power of domestic currency and increase inflation rate.

In the first two year the real value of domestic currency is comparatively lower than last 3 years because of negative BOP.

Thank You

Rahul Sunny answered 2 years ago

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