8. Explain how to compute the overall balance and discuss its significance. Answer: The overall balance is determined by computing the cumulative balance of payments including the current account, capital account, and the statistical discrepancies. The overall balance is significant because it indicates a country’s international payment gap that must be financed by the government’s official reserve transactions. 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. Answer: As foreigners purchase U.S. Treasury U.S. BOP will improve in the short run. But in the long run, U.S. BOP may deteriorate because the U.S. should pay interests and principals to foreigners. If foreign funds are used productively and contributes to the competitiveness of U.S. industries, however, U.S. BOP may improve in the long run. 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 and capital accounts should be equal in size, but opposite in sign, to the change in the official reserves: BCA + BKA = -BRA. Under the pure flexible exchange rate regime, central banks do not engage in official reserve transactions. Thus, the overall balance must balance, i.e., BCA = - Under the fixed exchange rate regime, however, a country can have an overall BOP surplus or deficit as the central bank will accommodate it via official reserve transactions. 11. Exhibit 3.5 indicates that in 1999, Germany had a current account deficit and at the same time a capital account deficit. Explain how this can happen? Answer: In 1999, Germany experienced an overall BOP deficit, which must have been accommodated by the central bank, e.g., drawing down its reserve holdings. 12. Explain how each of the following transactions will be classified and recorded in the debit
8. Explain how to compute the overall balance and discuss its significance. Answer: The overall balance is determined by computing the cumulative balance of payments including the current account, capital account, and the statistical discrepancies. The overall balance is significant because it indicates a country’s international payment gap that must be financed by the government’s official reserve transactions. 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. Answer: As foreigners purchase U.S. Treasury U.S. BOP will improve in the short run. But in the long run, U.S. BOP may deteriorate because the U.S. should pay interests and principals to foreigners. If foreign funds are used productively and contributes to the competitiveness of U.S. industries, however, U.S. BOP may improve in the long run. 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 and capital accounts should be equal in size, but opposite in sign, to the change in the official reserves: BCA + BKA = -BRA. Under the pure flexible exchange rate regime, central banks do not engage in official reserve transactions. Thus, the overall balance must balance, i.e., BCA = Under the fixed exchange rate regime, however, a country can have an overall BOP surplus or deficit as the central bank will accommodate it via official reserve transactions. 11. Exhibit 3.5 indicates that in 1999, Germany had a current account deficit and at the same time a capital account deficit. Explain how this can happen? Answer: In 1999, Germany experienced an overall BOP deficit, which must have been accommodated by the central bank, e.g., drawing down its reserve holdings. 12. Explain how each of the following transactions will be classified and recorded in the debit -
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