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Business Administration
Business Administration 4440Q/R/S/T
Brad Bisho

CHAPTER 3 BALANCE OF PAYMENTS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Define Balance of Payments. Answer: The Balance of Payments (BOP) is a 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 is useful to examine a country’s BOP for at least two reasons. First, the BOP provides detailed information about the supply and demand of the country’s currency. The trade statistics in the Current Account, for example, show the composition of trade – what a country imports and what it exports. The Capital Account shows inflows and outflows of capital in various categories. Second, viewed over time, BOP data can shed light on important developments in a country’s comparative advantage and international competitiveness. 3. The United States has run current account deficits continuously since the early 1980s. What do you think are the main causes for the deficits? What are the global consequences of continuous US current account deficits? Answer: The current account deficits of US may be linked to factors such as i. the relative ease by which the United States could borrow abroad to finance Current Account deficits ii. the high US rate of consumption (and correspondingly low savings rate) associated with large government deficits iii. US monetary policy that sustained relatively high US interest rates and a high value for the US dollar. IM-1 4. In contrast to the United States, 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 surpluses may have reflected a weak yen and high competitiveness of Japanese industries. Massive capital exports by Japan (purchases of US Securities, especially Treasury Bills) prevented yen from appreciating more than it did. At the same time, foreigners’ exports (of goods and services) to Japan were hampered by closed nature of Japanese markets. Sustained Current Account surpluses sometimes reflect export-promotion, import-discouraging policies in the deficit country. Such surpluses are inconsistent with free-trade to the extent that they are brought about by the mercantilist policies. 5. Comment on the following statement: “When Canada imports more than it exports, it is necessary for Canada to import capital from foreign countries to finance its Current Account deficits.” Answer: The Balance of Payments must balance. A deficit on Current Account ( “When Canada imports more than it exports ..”) means that Canada has spent more on imported goods and services than it has received in sales of (Canadian exported) goods and services. The Current Account deficit must be financed with an inflow of foreign capital involving the purchase of Canadian securities by foreigners who have more Canadian dollars than they know what to do with ( … “it is necessary for Canada to import capital from foreign countries to finance its Current Account deficits.”) which, of course, is a surplus on Capital Account. 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, Canada could run an overall BOP deficit by drawing down The Bank of Canada’s reserve holdings. Likewise, an overall BOP surplus can be absorbed by adding to the central bank’s reserve holdings. The Bank of Canada generally does not intervene – by using or accumulating foreign exchange reserves – to establish a specific value for the Canadian dollar vis-à-vis, say, the US dollar. The Bank of Canada is committed to a flexible exchange rate. As a result, the foreign exchange reserves of the Bank of Canada are relatively small unlike, say, Asian countries that hold substantial reserves in order to protect their currencies in the face of excess volatility. IM-2 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. F
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