Question

1.   Under the fixed exchange regime, if the country begins with a surplus in its overall balance of payments, to maintain the fixed exchange rate, explain the following

a)   How does the central bank intervene through monetary policy to affect the balance of payment?
b)   How does the central bank intervene through fiscal policy to affect the balance of payment?

Answer 1

1.(a) Central Bank can be increasing or decreasing the rate of interest and reserve requirements in order to maintain the required monetary policy which will be affecting the money flow in the economy, subsequently affecting the overall currency exchange rate into the economy and then it could be leading to increase or decrease in the current account deficit and then it can also be impacting the balance of payments.

Even though the currency is fixed in nature there would be the impact of the monetary policy on overall currency exchange rates which will be impacting the balance of payment.

In this case there is a surplus in the the fixed exchange rate regime so the Central Bank would be trying to decrease the interest rates in order to control the balance of payments.

B) the central bank can also intervene through the fiscal policy by increasing or decreasing the expenditure related with the central banks for stimulation in the demand of economy or control of the money flow in the economy so that it would be leading to fluctuations in the public expenditures and the collections so it will be impacting the over all monetary supply in the economy and it would lead to changes in the fiscal structure of the domestic country which would be impacted in the the balance of payment method through expenditure of public by increase or decrease of demand.

in this case the country will be trying to increase the public expenditure in order to have some effect on its books of accounts so that the surplus will be going down and the balance of payments could be evenly managed.