Question

[Financial capital in a country sloshes around in a pool. The funds going into the financial pool add to the level of the pool and funds withdrawn from the financial pool subtract from the level of the pool. But funds added to and subtracted from the pool at the same time don’t have to be (and rarely are) the same dollars.]  

6. Suppose a domestic country’s central bank pulls some foreign bonds out of its bond cache and sells them abroad. (The central bank would have had to purchase these foreign bonds at some previous time.)

(a) Which is this for the domestic country’s reserve transactions, money inflow or money outflow?

(b) What does this cause for the domestic country’s (narrow) balance of payments, a surplus or a deficit?

(c) What does this mean regarding the domestic country’s broad balance of payments?

For parts (d) and (e), suppose when the domestic country’s central bank sells the foreign bonds, it sells them to investors back in the (original) foreign country of issue.

(d) Which is this for the foreign country’s reserve transactions, money inflow or money outflow?

(e) What does this cause for the foreign country’s (narrow) balance of payments, a surplus or a deficit?

Answer 1

6. Suppose a domestic country’s central bank pulls some foreign bonds out of its bond cache and sells them abroad. (The central bank would have had to purchase these foreign bonds at some previous time.)

foreign bond is a bond issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising capital.

When central bank sells sold bonds it had previously purchased then it means that it is getting money and it will be credited to financial account.

(a) Which is this for the domestic country’s reserve transactions, money inflow or money outflow?

This is inflow of money as bonds purchased previously are being sold.

(b) What does this cause for the domestic country’s (narrow) balance of payments, a surplus or a deficit?

It will be credited to foreign portfolio investment. Hence it will be surplus. (Considering that there was earlier no surplus or deficit on balance of payment).

(c) What does this mean regarding the domestic country’s broad balance of payments?

Broad balance of payment will be positively affected as money is coming in the country and if there was any deficit on other account(example-current account )then it will be compensated by this addition of money.

For parts (d) and (e), suppose when the domestic country’s central bank sells the foreign bonds, it sells them to investors back in the (original) foreign country of issue.

(d) Which is this for the foreign country’s reserve transactions, money inflow or money outflow?

foreign bond is a bond issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising capital.

This will be outflow of money as foreign bonds are sold in that country in their own currency.

(e) What does this cause for the foreign country’s (narrow) balance of payments, a surplus or a deficit?

This will cause deficit in country's balance of payments as money will be debited on financial account.