Answer to Question #222660 in Macroeconomics for Ernestaro

Question

Suppose that an exogenous disturbance, such as a change in government policy, leads to a balance of payments deficit and a consequent fall in the exchange rate. Discuss the effects of the new exchange rate level on the balance of payments and the exchange rate.

Answer 1

Any change in balance of payments fluctuates the rate of exchange. Low exchange rate makes imports expensive as export become cheaper. High exchange rate on the other hand makes imports cheaper as export become expensive. Therefore this leads to balance of payments because any transaction that causes money to flow into a country is a credit to its balance of payment account, and any transaction that causes money to flow out is a debit.