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Balance of Payments Problems

Balance of Payments Problems

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Published by MainSq

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Published by: MainSq on Apr 19, 2011
Copyright:Attribution Non-commercial


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Balance of payments problems
What are balance of payments problems?
Balance of payments problems arise generally due to existence of deficits in the current andcapital accounts. The transactions that are in the capital and current accounts as autonomoustransactions or items above the line. They are known as such because the transactions arebeing undertaken either in foreign exchange market or the commodity market without theparticipants being aware of their actions the balance of payments effects e.g. when residentstransfer money abroad either as investment material or donations/ gifts have no cluewhatsoever of these balance of payments effects.
Causes of B.O.P problems
There are numerous factors that influence B.O.P problems in countries but the most commonof these is the use of the fixed exchange rate regime. In this case the foreign exchange rate isusually se below the equilibrium exchange rate thus over valuing the local currency. Asconsequence, it becomes the imports will be cheap as compared to the exports. This meansthat the demand for imports will surpass that of exports bringing about a higher debit balance.Other causes of inflation may include; high inflation rates, level of economic growth,government borrowing habits, transfer money abroad, recession in other countries,deterioration of the current account etc.
Adjustment of B.O.P deficits
It is only under a freely floating/ flexible exchange rate regime that the equilibrium exchangerate is established, under the managed float and the fixed/ pegged exchange rate regimes, theexchange rate will be set either above or below the equilibrium level bringing about a surplusor a deficit in the balance of payments account. In this case we will only concentrate on thedeficit side and how to adjust it. The various ways of adjusting the deficit balance include;
Use of expenditure reducing policies
These policies include the monetary and the fiscal policies. Adjustments in the items of thesetwo components are what bring about changes in the deficit balances of the balance of payments account. The basic items used when using the monetary policies are interest ratesand open market operations while when using fiscal policies the basic items are taxation anddirect government expenditures.
Expenditure switching policies

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