CHAPTER 3 BALANCE OF PAYMENTS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. Define the balance of payments.
The balance of payments (BOP) can be defined as the statistical record of a country’s
international transactions over a certain period of time presented in the form of double-entry bookkeeping.
2. Why would it be useful to examine a country’s balance of payments data?
Answer: It 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 have 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?
Japan’s continuous current account surpluses 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’ exports to Japan were hampered by closed nature of Japanese markets. Continuous current account surpluses disrupt free trade by promoting protectionist sentiment in the deficit country. It is not desirable especially when it is brought about by the mercantilist policies.
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 encouraging 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 reserve holdings.
7. Explain official reserve assets and its major components.
Answer: Official reserve assets are those financial 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 computing the cumulative balance of payments including the current account, capital account, and the statistical discrepancies. The overall BOP is significant because it indicates a country’s international payment...
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