Question

In the model of the timing of a balance of payments crisis, we can argue that there is a critical time (call it T) at which a country will lose all of its reserves in an instant. What happens to that critical time if the country devalues its currency? What would happen if instead, some international agency were to give more reserves to the country? Explain the logic of your answer.

Answer 1

Devaluation means the import prices of a country will increase while it's exports price will fall. This is because now each unit of domestic currency is less in worth in terms of foreign currency. So devaluation will give competitiveness to our goods which are less costly in comparison to foreign goods. So our exports will increase imports will fall and balance of payments will improve and reserves will start building. But one thing should be kept in mind that devaluation should be real otherwise there won't be any gain in competitiveness .

If some international agency gives us reserve the it can be helpful only in short run . You can't always borrowing from international agency because borrowing toohad cost. In long run the only way to move out of crisis is to devise some policies to bring external balance into surplus without affecting internal balance I.e level of employment.

T