Page 219 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes The BOP must always equal 0, i.e., balance since it is an accounting identity in a fixed
exchange rate system.
When payments are larger than receipts in international transactions, it is called deficit
balance of payments, but when receipts are larger than payments, it is called surplus
balance of payments.

Short-term disturbances like floods, crop failures, drought and so on may raise imports
and reduce exports, and Increase in income may lead to more imports and less exports
lead to an imbalance in BOP.
Prior to 1956-57, for most years in the fifties, India had a current account surplus. But the
position changed in 1956-57, when India faced BOP crisis.

A flexible exchange rate has been adopted since 1971. In this system, the price of foreign
currencies varies according to their market demand and supply position.
At the existing rate of exchange, country’s BOP moves into deficit, then the quantity of that
country’s currency supplied to the foreign exchange market will exceed the demand for it.
The currency will, therefore, depreciate against other currencies and, in consequence,
demand for exports will increase (because they have become cheaper abroad) while demand
for imports will fall (because they have become more expensive in the domestic economy).

12.6 Keywords

Balance of Payments: Record of all transactions made between one particular country and all
other countries during a specified period of time.
Deficit Balance of Payments: When payments are larger than receipts in international transactions.

Devaluation: It means an official reduction in the external value of a currency vis-à-vis gold or
other currencies.
Exchange Control: It refers to government regulation of exchange rate as well as restriction on
the conversion of local currency into foreign currency.
Expenditure Switching Policies: It involves policies that cause domestic spending to switch
away from imports to home produced goods

Floating Exchange Rate: A country’s exchange rate regime where its currency is set by the
foreign-exchange market through supply and demand for that particular currency relative to
other currencies.
Official Reserve Account: It measures the foreign currency and securities held by the central
bank, and is used to balance the payments from year to year.
Surplus balance of payments: When receipts are larger than payments in international
transactions.

12.7 Review Questions

1. Explain the following: (a) The current account, (b) The capital account and, (c) The official
reserve account.
2. Distinguish between balance of trade and balance of payments. What information would
you get about the economic position of a country from its BOP?
3. Describe the term disequilibrium in balance of payments. State various conscious policy
measures to correct this disequilibrium.

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