Give an example of how the balance of payments provides information co

Give an example of how the balance of payments provides information concerning exchange rate determination?

What will be an ideal response?

ANSWER

Answer: The balance of payments provides information that is useful in understanding the determination of exchange rates and the growth prospects of a country. Persistent, large current account deficits, especially ones that are primarily consumer driven, are often associated with currency crises in which the currency of the country with the deficit depreciates substantially and the country suffers a severe recession. Knowledge of the official settlements account indicates whether the country is gaining or losing international reserves. Massive increases in international reserves indicate that the central bank is resisting pressure for the currency to appreciate in value. Large capital account surpluses that are primarily driven by private sector investments indicate that foreigners find the assets of the country to be attractive investment opportunities.