Process of adjustment

Process of adjustment

The balance of payments of a country is undergoing continuous adjustment.This adjustment is in response to the various economic forces that impact a country’s balance of payments.

Inflation and changes in relative prices bring about changes in balance of payments transactions.Differences in inflation from country to country affect the competitive position of goods and services that are traded.With excessive inflation countries tend to experience an increase in imports and a decline in exports.We can refer to changes in balance of payments due to differences in inflation as part of a price level mechanism.

Differences in real economic growth between countries also impact their respective balance of payments.Countries with slow growth in real income generally experience similar slow growth in imports.Conversely, countries with high income growth tend to experience more rapid growth in imports.Finally, countries with high growth rates may exhibit high real interest rates in their respective capital markets.High real interest rates attract capital inflows.We refer to these balance of payments influences based on differences in economic growth rate as an economic activity mechanism.

Countries with high or rising interest rate levels tend to experience capital inflows.By contrast, countries with low or declining interest rate levels tend to experience capital outflows.In recent years, the volume of cross-border capital flows based on interest rate differences appears to have been increasing.These capital flows operate as a balancing or financing component in a nation’s balance of payments.In effect, a capital flow mechanism influences the balance of payments position and that works through changing levels of investment inflows and outflows.

Changes in foreign exchange rates also influence balance of payments transactions.A rise in the value of a nation’s currency reduces the competitiveness of that nation’s exports and also makes imports more attractively priced to residents.In contrast, a fall in the value of a nation’s currency enhances the competitiveness of that nation’s exports and makes imports less attractive to residents.This exchange rate mechanism plays an important role in adjusting a country’s balance of payments position.

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1.The balance of payments is the record of the economic and financial flows that take place over a specified time period between residents and non-residents of a given country.

2.Balance of payments accounting is based on the double entry system of bookkeeping.Every source has a corresponding use and vice versa.Thus, the overall balance of payments will always be equal to zero.

3.The most common practice is to divide the balance of payments into the current account and the capital account.The current account includes exports and imports of all goods and non-financial services, investment income and unrequited transfers.The capital account includes direct investment, portfolio investment, other long and short-term capital and the change in official reserves.

4.Four key economic forces influence a country’s balance of payments flows.They are the inflation rate, real GNP growth rate, interest rates, and the spot rate of exchange.