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CHAPTER 3 BALANCE OF PAYMENTS
ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
QUESTIONS
1. Define balance of payments.
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
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 be attributable to (i) the strong dollar and
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
5. Comment on the following statement: “Since the United States imports more than it exports,
it is necessary for the United States to import capital from foreign countries to finance its current
account deficits.”
6. Explain how a country can run an overall deficit or surplus on its balance of payments.
7. Explain official reserve assets and its major components.
8. Explain how to compute the overall balance and discuss its significance.
9. Since the early 1980s, foreign portfolio investors have purchased a significant portion of U.S.
treasury bond issues. Discuss the short-term and long-term effects of foreigners’ portfolio
investment on the U.S. balance of payments.
10. Describe the balance of payments identity and discuss its implications under the fixed and
flexible exchange rate regimes.
Answer: The balance of payments identity holds that the combined balance on the current,
11. Exhibit 3.6 indicates that in 2013, China had a current account surplus and at the same
time a financial account surplus. Explain how this can happen?
12. Explain how each of the following transactions will be classified and recorded in the debit
(1) A Japanese insurance company purchases U.S. Treasury bonds and pays out of its bank
account kept in New York City.
(2) A U.S. citizen consumes a meal at a restaurant in Paris and pays with her American Express
card.
(3) A Indian immigrant living in Los Angeles sends a check drawn on his L.A. bank account as a
gift to his parents living in Mumbai.
(4) A U.S. computer programmer is hired by a British company for consulting and gets paid from
the U.S. bank account maintained by the British company.
Answer:
_________________________________________________________________
Transactions Credit Debit
_________________________________________________________________
Japanese purchase of U.S. T bonds
_________________________________________________________________
13. Construct the balance of payment table for Germany for year 2018 which is comparable in
format to Exhibit 3.1, and interpret the numerical data. You may consult International Financial
Statistics published by IMF or search for useful websites for the data yourself.
Answer: A summary of the German Balance of Payments for 2018 (in $ billion)
Credits
Debits
Current Account
[1] Exports
1,869.9
[2] Imports
-1,630.3
Source: Balance of Payments and International Investment Position Statistics, IMF
14. Discuss the possible strengths and weaknesses of SDRs versus the dollar as the main
reserve currency. Do you think the SDR should or could replace the U.S. dollar as the main
global reserve currency?
Answer: Being a basket currency, SDR has a relatively stable exchange value. However, IMF,
PROBLEMS
1. The U.S. Balance of Payments for year 2017.
Solution:
MINI CASE: MEXICO’S BALANCE OF PAYMENTS PROBLEM
Recently, Mexico experienced large-scale trade deficits, depletion of foreign reserve
holdings and a major currency devaluation in December 1994, followed by the decision to freely
float the peso. These events also brought about a severe recession and higher unemployment
in Mexico. Since the devaluation, however, the trade balance has improved.
Investigate the Mexican experiences in detail and write a report on the subject. In the
report, you may:
(a) document the trend in Mexico’s key economic indicators, such as the balance of payments,
the exchange rate, and foreign reserve holdings, during the period 1994.1 through 1995.12.;
(b) investigate the causes of Mexico’s balance of payments difficulties prior to the peso
devaluation;
Suggested Solution to Mexico’s Balance of payments Problem
To solve this case, it is useful to review Chapter 2, especially the section on the Mexican
peso crisis. Despite the fact that Mexico had experienced continuous trade deficits until
December 1994, the country’s currency was not allowed to depreciate for political reasons. The
Mexican government did not want the peso devaluation before the Presidential election held in
