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Balance Of Payments Deficit Or Surplus

3265 words - 13 pages

"Because each nation's balance of payments equals zero, it follows that there is actually no significance to a balance of payments deficit or surplus." Discuss.Executive SummaryMacroeconomic is concerned with the overall performance of the economy. Macroeconomic did not even exist in its modern form until 1936, when John Maynard Keynes published his revolutionary theory. In his theory Keynes developed an analysis of what causes business cycles, with alternating spells of high unemployment and high inflation. Today, macroeconomics examines a wide variety of areas, such as how total investment and consumption are determined, how central banks manage money and interest rates, what causes international financial crisis, and why some nations grow rapidly while other stagnate. Although macroeconomics has progressed far since first insights, the issues addressed by Keynes still define the study of macroeconomics today.A country's balance of payment account records all transactions between the residents of that country and the rest of the world. These transactions enter as either debit items or credit items. The debit items include all payments to other countries: these include the country's purchases of imports, the spending on investment it makes abroad and the interest and dividends paid to people abroad who have invested in the country. The credit items include all receipts form other countries: from the sales of exports, from inward investment expenditure and from interest and dividends earned from abroad. (John Sloman, Essentials of Economics, page 462-265)The sale of exports and any other receipts earn foreign currency. The purchase of imports or any other payments abroad use up foreign currency. If we start to spend more foreign currency than we earn, one of two things must happen. Both are likely to be a problem.The balance of payments will go into deficit. In other words, there will be shortfall of foreign currencies. The government will therefore have to borrow money from abroad, or draw on its foreign currency reserves to make up the shortfall. This is a problem because, if it goes on too long, overseas debts will mount, along with the interest that must be paid; and/or reserves will begin to run low.The exchange rate will fall. The exchange rate is the rate at which one currency exchanges for another. For example, the exchange rate of the pound into the dollar might be ₤1= $1.60.If the government does nothing to correct the balance of payments deficit, then the exchange rate must fall: for example, to $1.55 or $1.50, or lower. A falling exchange rate is a problem because it pushes up the price of imports and may fuel inflation. Also, if the exchange rate fluctuates, this can cause great uncertainty for traders and can damage international trade and economic growth. (John Solman, Essentials of Economics, page 251-252)IntroductionWhen all the components such as current account, capital account, financial account of the balance of...

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