The significance of a deficit or surplus in the BOP has changed since the advent of floating exchange rates. This pressure led to governmental transactions that were compensatory in nature, forced on the government by its need to settle the deficit or face a devaluation. The relationship between the BOP and exchange rates can be illustrated by use of a simplified equation that summarizes BOP data:
How does the balance of payments impact currency exchange rates? Lioudis Updated June 13, — A change in a country's balance of payments can cause fluctuations in the exchange rate between its currency and foreign currencies.
The reverse is also true when a fluctuation in relative currency strength can alter the balance of payments.
There are two different and interrelated markets at work: These conditions only exist under a free or floating exchange rate regime. The balance of payments does not impact the exchange rate in a fixed-rate system because central banks adjust currency flows to offset the international exchange of funds.
The world has not operated under any single rules-based or fixed exchange-rate system since the end of Bretton Woods in the s. To explain further, suppose a consumer in France wants to purchase goods from an American company. The American company is not likely to accept euros as payment; it wants U.
Somehow the French consumer needs to purchase dollars ostensibly by selling euros in the forex market and exchange them for the American product.
Today, most of these exchanges are automated through an intermediary so that the individual consumer doesn't have to enter the forex market to make an online purchase. After the trade is made, it is recorded in the current account portion of the balance of payments.
The same holds true for investments, loans or other capital flows. American companies normally do not want foreign currencies to finance their operations, thus their expectation for foreign investors to send them dollars.
In this scenario, capital flows between countries show up in the capital account portion of the balance of payments. Put another way, it costs relatively more to exchange for dollars, in terms of foreign currencies. The exchange rate for dollars may not actually rise if other factors are concurrently pushing down the value of dollars.
For example, expansionary monetary policy might increase the supply of dollars.Under this standard, rate of exchange is pegged at mint parity, that is, the gold equivalent of the standard monetary units of the currencies.
It can move only within the “gold points”, that is the mint parity ± cost of transporting gold from one country to the other. The relative version of PPP relates changes over time in an equilibrium exchange rate to changes in a country‟s relative price levels. In other words, the relative version of .
The Balance of Payments and the Exchange Rate In today's global economy world, the phenomenon of the "closed economy" —one that is unaffected by international trade and capital flows— is little more than an abstract textbook concept. The notion of a closed economy is nevertheless quite.
The balance of payments theory of exchange rate holds that the price of foreign money in terms of domestic money is determined by the free forces of demand and supply on the foreign exchange market.
It follows that the external value of a country's currency will . relationship between exchange rate volatility and BOP in Kenya.
The study adopted a quantitative comparative design to determine the relationship between the two variables.
Exchange rate • Also known as the foreign-exchange rate, forex rate or FX rate • The exchange rates between two currency specifies how much one currency is worth in terms of the other.
• It is the value of a foreign nation’s currency in terms of the home nation’s currency.