Balance of Payments Test - 4

Managed flow regeime is the current international finance environment in which exchange rates fluctuate from day to day, but central banks attempt to influence their countries' exchange rates by buying and selling currencies. It is also known as a dirty flow.

In an increasingly integrated world economy, the currency rates impact any given country's economy through the trade balance. In this aspect, almost all currencies are managed since central bank or government intervene to influence the value of their currencies.

Balance of payments includes all external visible and non-visible transactions of a country.  If a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down currency reserves or by receiving loans from other countries.

When price of a foreign currency rises, domestic goods become relatively cheaper. It induces the foreign country to increase their imports from the domestic country

The difference between the value of goods and services exported out of a country and the value of goods and services imported into the country. The balance of trade is the official term for net exports that makes up the balance of payments. The balance of trade can be a "favorable" surplus (exports exceed imports) or an "unfavorable" deficit (imports exceed exports). The official balance of trade is separated into the balance of merchandise trade for tangible goods and the balance of services.

Current account of balance of payment is trade balance & trade balance includes exports and imports of goods and services.

 All transactions relating to borrowings from abroad by private sector, government, etc. Receipts of such loans and repayment of loans by foreigners are recorded on the positive (credit) side.

All transactions of lending to abroad by private sector and government. Lending abroad and repayment of loans to abroad is recorded as negative or debit item.

Capital account of BOP records all those transactions, between the residents of a country and the rest of the world, which cause a change in the assets or liabilities of the residents of the country or its government. It is related to claims and liabilities of financial nature.

Balance of payment account is a systematic record of all economic transactions between residents of home country and residents of foreign countries during a given point of time.

Foreign exchange rate defines the price of currency of domestic country in terms of foreign currency

The nominal exchange rate is defined as the number of units of the domestic currency that can purchase a unit of a given foreign currency. A decrease in this variable is termed nominal appreciation of the currency.

yes it contradicts with the objectives of free markets .It can be explained as

suppose,

· If a currency is falling below its band the government will have to intervene. It can do this by buying sterling but this is only a short term measure.

· The most effective way to increase the value of a currency is to raise interest rates. This will increase hot money flows and also reduce inflationary pressures.

· However higher interest rates will cause lower AD and economic growth, if the economy is growing slowly this may cause a recession and rising unemployment

Currency's value goes up (or down) if the demand for it goes up more (or less) than the supply does. In the short run this can happen unpredictably for a variety of reasons, having to do with trade flows,speculation, or other factors in the international capital market.

A fixed exchange rate is a country's exchange rate regime under which the government or Central bank ties the official exchange rate to another country's currency or to the price of gold. The purpose of a fixed exchange rate system is to maintain a country's currency value within a very narrow band.

A currency legal tender in the country in which it is printed and not legal tender in other country unless it is exchanged for foreign currency.

Flexible exchange rate is determined by the forces of demand and supply i.e. where demand equals supply eliminating the undervaluation or overvaluation of currencies.

 It is determined by market forces because every currency area must decide what type of exchange rate arrangement to maintain. Between permanently fixed and completely flexible however, are heterogeneous approaches. They have different implications for the extent to which national authorities participate in foreign exchange markets.

flexible exchange rates creates instablity because there is too frequent fluctuations in exchange rate under it create uncertainty about the exact amount of receipts and payments in foreign exchange transac­tions.And this instability hampers foreign trade and capital movements between the countries.

Increase  in domestic currency price of the foreign currency implies decrease in the purchasing power of  domestic currency in terms of foreign currency .

It leads to increase in the purchasing power of domestic currency in terms of foreign currency as we require to pay less per unit of foreign currency now.

Real exchange rate says how much of goods in domestic country can be exchanged for goods in foreign country. Nominal exchange rate cannot tell us that.

A trade surplus is an economic measure of a positive balance of trade, where a country's exports exceed its imports. A trade surplus represents a net inflow of domestic currency from foreign markets. trade surplus helps to strengthen a country’s currency; however, this is dependent on the proportion of goods and services of a country in comparison to other countries as well as other market factors. Countries can also highly control their currency through foreign investment efforts.

Foreign Exchange is demanded to make the payment for imports of goods and services.

flexible exchange-rate system is a monetary system that allows the exchange rate to be determined by supply and demand.As it variates according to market forces.

 Exchange rate stability, it is said, is necessary for orderly development of the international economy and rapid growth of world trade.

If the exchange rate is unstable or variable, the exporters will not be certain about the price they would receive for the goods to be expedited by them; the importers will not be certain about the price and the payments they have to make for their imports.

A trade deficit  represents  outflow  of domestic currency that takes place when value of imports exceed value of exports.

Real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign country.