Question

Q3 Balance of Payments (I)

The citizens of Shortland, whose currency is the squat, conducted the following transactions in 2008/09:

Item	Billions of squats
Exports of goods and services	40
Imports of goods and services	50
Net income and transfer	x
Borrowing from the rest of the world	2
Lending to the rest of the world	12
Change in reserve assets	0

(a) What is the value of net income and transfers (x)?

(b) Set out the balance of payments accounts for Shortland.

(c) Does Shortland have a floating exchange rate?

Answer 1

A) as BOP should be zero

So 40-50+x + 12-2+0 = 0

Thus, -10+x + 10 = 0

So x = 0

B) BOP = current account balance + capital account balance + change in net reserves

Current account = exports - imports + net income & transfer

= 40-50 +0

= -10

Capital account = lending to ROW - borrowing from ROW

= 12-2 = 10

C) since change in reserve assets = zero.

So it implies fixed exchange rate.

Reserve assets imply that central bank uses its official foreign exchange reserves to correct for BOP imbalances .

So no change in reserve assets imply no intervention in foreign exchange market , so exchange rate system is fixed.