Page 150 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes An additional issue should be mentioned before we proceed to the test. It should be obvious that
sterilization of the effects of changes in official holdings of foreign exchange reserves on the money
supply is impossible under fixed exchange rates when assets can be freely bought and sold across
international boundaries. Suppose that the demand for nominal money holdings declines and R
falls. Any attempt of the authorities to offset this fall in R by an increase in Dsc will lead to a further
fall in R equal to that increase in Dsc. The government has no control over the domestic money
supply under fixed exchange rates.
It is time for a test. Figure out your own answers to the questions before looking at the ones provided.

The difference between speculative pressures under flexible and fixed exchange rates
is that under flexible exchange rates it is harder to guess which way the rate is likely
to move in the future. When speculative pressures arise under fixed exchange rates
it is usually quite clear in which direction, if any, the exchange rate will move.

Types of BOP Equilibrium
There are two types of BOP equilibrium, i.e., static equilibrium and dynamic equilibrium :
(a) Static Equilibrium : The distinction between static and dynamic equilibrium depends upon
the time period. In static equilibrium, exports equal imports including exports and imports of
services as well as goods and the other items on the BOPs – short term capital, long term capital
and monetary gold are on balance, zero. Not only should the BOPs be in equilibrium, but also
national money incomes should be in equilibrium vis-a-vis money incomes abroad. The foreign
exchange rate must also be in equilibrium.
(b) Dynamic Equilibrium : The condition of dynamic equilibrium for short periods of time is that
exports and imports differ by the amount of short-term capital movements and gold (net) and
there are no large destabilising short-term capital movements.
The condition for dynamic equilibrium in the long run is that exports and imports differ by the
amount of long term autonomous capital movements made in a normal direction, i.e. from the
low-interest rate country to those with high rates. When the BOP of a country is in equilibrium,
the demand for domestic currency is equal to its supply. The demand and supply situation is
thus neither favourable nor unfavourable. If the BOP moves against a country, adjustments
must be made by encouraging exports of goods, services or other forms of exports or by
discouraging imports of all kinds. No country can have a permanently unfavourable BOP,
though it is possible – and is quite common for some countries – to have a permanently
unfavourable balance of trade. Total liabilities and total assets of nations, as of individuals,
must balance in the long-run.
12.2 Disequilibrium in Balance of Payments

Meaning of Disequilibrium in Balance of Payment
Though the credit and debit are written balanced in the balance of payment account, it may not
remain balanced always. Very often, debit exceeds credit or the credit exceeds debit causing an
imbalance in the balance of payment account. Such an imbalance is called the disequilibrium.
Disequilibrium may take place either in the form of deficit or in the form of surplus.
Disequilibrium of Deficit arises when our receipts from the foreigners fall below our payment to foreigners.
It arises when the effective demand for foreign exchange of the country exceeds its supply at a given rate
of exchange. This is called an ‘unfavourable balance’. Disequilibrium of Surplus arises when the receipts
of the country exceed its payments. Such a situation arises when the effective demand for foreign exchange
is less than its supply. Such a surplus disequilibrium is termed as ‘favourable balance’.

144 LOVELY PROFESSIONAL UNIVERSITY