CHAPTER 3 BALANCE OF PAYMENTS
SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
QUESTIONS
1. Define the balance of payments.
Answer: 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?
Answer: 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
