Question

Question 10. Provide the balance of payments definition and explain
what means the balance of payments equilibrium. Moreover, answer the
following questions: (BOP=CA+KA+FA+SD+RES)
(a)What is the relationship between balance of payments and the supply
of domestic currency?
(b)What problems may arise as a result of a long term balance of
payments deficit and a balance of payments surplus?
(c) What is the role of sterilization policy in offseting the balance of
payments inequilibrium?

Answer 1

10)definition of Balance of Payment

BOP is a record of all international trade and financial transaction made by country's resident.If deficit is high that means import is higher and if there is surplus it shows profit.Balance of payment of a country is in equilibrium means demand for domestic currency is equal to its supply.

CA= current account

KA= Capital account

FA=Financial account

SD=statistical discrepancy

RES=reserve balance of payment

BOP=CA+KA+FA+RES+BOP

a)Change in country 's balance of payment can cause fluctuation in exchange rate of the country. There is a direct correlation between BOP And supply of money , if there is a surplus in BOP then certainly home land currency will apppreciate and demand over supply will increase.

b) Deficit in BOP occurs only when there is excess of import over export, but with the long term deficits there occurs various problems such as

1. Value of currency will fall thus weakens our currency .
2. Too much dependcy on foreign goods.
3. Home industries will shut down in that case it will effect on employment of our nation.
4. Due to unemployment there will be recession as standard of living will go down.
5. constant deficit in BOP will lead to increased in tax .
6. with constant deficit GDP will go down.

Therefore there will be a ripple effect on the economy.

c)Sterliization is a form of monetary action in which central bank will limit the effect of inflow and outflows of capital on money supply.

sterilization will reduce or offset the impact of currency appreciation or currency depreciation. thus try to bring balance impact in international trade.