CHAPTER 3 BALANCE OF PAYMENTS
SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
1. Define the balance of payments.
Answer: The balance of payments (BOP) can be de
fined as the statistical record of a country’s
international transactions over a certain period of
time presented in the form of double-entry
2. Why would it be useful to examine
a country’s balance of payments data?
It Answer: would be useful to examine a country’s
BOP for at least two reasons. First, BOP provides
detailed information about the supply and demand of the country’s currency. Second, BOP data can be used to evaluate the performance of the country in
international economic competition. For example, if a
country is experiencing perennial
BOP deficits, it may signal that the country’s industries lack competitiveness.
3. The United States has experienced continuous current account deficits since the early 1980s. What do you think are the main causes for the deficits? What would be the consequences of continuous U.S. current account deficits? Answer: The current account deficits of U.S. may ha
ve reflected a few reasons such as (I) a historically
high real interest rate in the U.S., which is due to
ballooning federal budget deficits, that kept the dollar
strong, and (ii) weak competitiveness of the U.S. industries. ? 4. In contrast to the U.S., Japan has realized
continuous current account surpluses. What could be the main causes for these surpluses? Is it desirable to have continuous current account surpluses? Answer: Japan’s continuous current account surp
luses may have reflected a weak yen and high
competitiveness of Japanese industries. Massive capital
exports by Japan prevented yen from appreciating
more than it did. At the same time, foreigners’ expor
ts to Japan were hampered by closed nature of
Japanese markets. Continuous current account surplu
ses disrupt free trade by promoting protectionist
sentiment in the deficit country. It is not desirabl
e especially when it is brought about by the mercantilist
5. Comment on the following statement: “Since the U.S. imports more than it exports, it is necessary for the U.S. to import capital from foreign countries to finance its current account deficits.” Answer: The statement presupposes that the U.S.
current account deficit causes its capital account
surplus. In reality, the causality may be running in
the opposite direction: U.S. capital account surplus
may cause the country’s current account deficit. Suppose
foreigners find the U.S. a great place to invest
and send their capital to the U.S., resulting in U.S.
capital account surplus. This capital inflow will
strengthen the dollar, hurting the U.S. export and en
couraging imports from foreign countries, causing
current account deficits.
6. Explain how a country can run an overall balance of payments deficit or surplus. Answer: A country can run an overall BOP deficit or
surplus by engaging in the official reserve
transactions. For example, an overall BOP deficit can
be supported by drawing down the central bank’s
reserve holdings. Likewise, an overall BOP surplus can
be absorbed by adding to the central bank’s
7. Explain official reserve assets and its major components. Answer: Official reserve assets are those financia
l assets that can be used as international means of
payments. Currently, official reserve assets comprise:
(I) gold, (ii) foreign exchanges, (iii) special
drawing rights (SDRs), and (iv) reserve positions with
the IMF. Foreign exchanges are by far the most
important official reserves.
8. Explain how to compute the overall balance and discuss its significance. Answer: The overall BOP is determined by computi
ng the cumulative balance of payments including the
current account, capital account, and the statistical
discrepancies. The overall BOP is...
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