Sample Essay on Impact of Balance of Payment on Exchange Rate
Economic transactions vary greatly in the world. Currencies from different nations are traded in the foreign exchange market where most of these currencies rise or fall against other trading currencies with changes in demand and supply. It is considered that the demand for a certain currency is directly connected to the supply of the other currency. There are different factors that affect the exchange rate of currencies. Nevertheless, the balance of payment is one of the key factors to look at and ascertain more on how the exchange rate of currencies is undertaken.
The balance of payments [BoP] of a country is the record of all economic transactions that occur between the citizens of a country and the rest of the world within a particular duration. These transactions are usually made by individuals, government entities, or firms. In essence, the balance of payments involves all the visible and non-visible transactions of a country within a year. Evidently, it represents a rundown of the country’s current supply and demand of the assertions of foreign assertions on its currency.
When all the elements of the BoP are considered they must sum to zero with no complete deficit on the currency used. The complete BoP accounts will always balance when all necessary payments are made. In the case of the current account, the capital account excluding the central banks’ reserve or the total of the two may result in imbalances. In cases of any imbalances, there is also a possibility that the surplus in this country may lead to the accumulation of wealth while the deficit country may experience an increase in its public debts.
Whenever there is a change in the exchange rate, there is a vast impact on the balance of payments. However, these effects may come with time holdups. For instance, when the sterling is strong than any other currency, the price of the UK goods and services in the foreign markets will rise and the UK exporters will have difficulties trading their commodities in other nations. In addition, it is easy and budget-friendly for UK consumers to buy imported goods and services. This is because the pound buys more foreign currency than it did before. Interestingly, a strong pound may affect the balance of trade as much depends on the value of price elasticity of demand for imports and exports within the trading countries.
Balance of payment also affects the living standards of a nation. Generally, it is a common misconception that balance of payments deficits are not good for a country’s economy, but this is not what it seems to be. There is nothing wrong with a trade discrepancy. This means that a country may rely on foreign direct investment or lend money in order to cover up the deficit.
Essentially, if a country is importing huge commodities this is a boost to the living standard as consumers will be able to buy more products without any qualms. There are a number of policies that can be utilized to reduce the impact of balance payment on exchange. Fundamentally, these are policies that can be utilized to achieve an improvement in the country’s exchange rate balance.
A number of these policies focus on change in the growth of demand or to enhance the supply-side of the country’s economy. This includes demand management- where you create balance in government spending and taxation and interest rate variation. A lower exchange rate offers a way to enhance competition and reduce overseas prices of commodities. Lastly, we have supply-side improvement where we apply policies to raise productivity, spur business start-ups, and invest in modern critical infrastructures to support businesses.
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