Chapter 4 – BALANCE OF PAYMENTS
As long as most of the major industrial countries were still operating under fixed
exchange rates, the interpretation of BOP was relatively straightforward.
•A surplus in the BOP implied that the demand for the country’s currency exceeded
the supply and tha the government should allow the currency value to increase in
value – or intervene and accumulate additional foreign currency reserves in the
official reserves account.
•A deficit in the BOP implied an excess supply of the country’s currency on world
markets, and the government would then either devalue the currency or expend its
official reserves to support its value.
Fixed exchange rate countries.
Under a fixed exchange rate syste, the government owns the responsibility to ensure that
the BOP is near zero.
IF THE SUM OF THE CURRENT AND CAPITAL ACCOUNTS DO NOT
APPROXIMATE ZERO,
THE GOVERNMENT IS EXPECTED TO INTEVENE IN THE FOREIGN EXCHANGE
MARKET BY BUYING OR SELLING OFFICIAL FOREIGN EXCHANGE RESERVES.
IT IS OBVIOUSLY IMPORTANT FOR A GOVERNMENT TO MAINTAIN
SIGNIFICANT FOREIGN EXCHANGE RESERVE BALANCES, SUFFICIENT TO
ALLOW IT TO INTERVENE EFFECTIVELY.
IF THE COUNTRY RUNS OUT OF FOREIGN EXCHANGE RESERVES, IT WILL BE
UNABLE TO BUY BACK ITS DOMESTIC CURRENCY AND WILL BE FORCED TO
DEVALUE.
Floating exchange rate countries.
The government HAS NO RESPONSBILITY TO PEG RATES AND A COUNTRY
RUNNING A DEFICIT OR SURPLUS WILL AUOMATICALL ALTER THE
EXCHANGE RATE IN THE DIRECTION TO OBTAIN A BOP NEAR ZERO.
FOR EXAMPLE, A COUNTRY RUNNING A SIZABLE CURRENT ACCOUNT
DEFICIT WITH A CAPITAL AND FINANCIAL ACCOUNTS BALANCE OF
