MONEY AND FINANCE

International Money and Finance Assignment

International Money and Finance Assignment

Introduction

Balance of payments, exchange rate regime and monetary policy are basic factors that play an imperative role in the economic development of a country like UK. It is very difficult for a country to control the exchange rate variation without proper control over its balance of payments (Meader & Tily 2008, p. 33). High payment balances lead to depreciation of the home currency that means an appreciation of foreign exchange rates. This appreciation makes the imports of goods and assets more expensive and exports cheap. As a result the demand for domestic products and services increases due to expensive imports and cheap exports. If the local producers fail to fulfil this excessive demand then imports increases and exports decrease and cause a deficit in balance of payments. It also makes upward pressure on local market prices and causes high inflation.

Deficit in balance of payments induces authorities to fix the exchange rate by pegging the currency or adopting a currency board. The rapid changes in the exchange rate regime disturb the monetary policy. Under different exchange rate regimes the monetary authorities play different role for controlling the foreign exchange rate (McCombie 1997 p. 375). It has been observed that under the free floating exchange rate regime, monetary authorities are more freely implement policies than any other type of regime. The deficit in the balance of payments affects, including changes in exchange rates and in interest rates, affect directly or indirectly all parts of the economy.

The main objective of this paper is to find out the keen relationship between balance of payments, exchange rate regime and monetary policy; they are correlated with each other and effect the economic growth of a country (Bernstein 2008). We find that changes in the balance of payments (deficit or surplus) cause changes in the exchange rate regime. This report provides a comprehensive analysis of balance of payment for UK, keeping in view the theory and existing empirical evidence in your discussion.

Swings in the Current Account Balance

The balance of payments is an account that systematically measures all economic transactions between the home country and rest of world over a specific period of time. The transactions are measures in term of receipts and payments. It covers the exchange of all goods and service (Kemp 2008 45). The balance of payments is composed of three major accounts: current account, capital account and reserve account. The current account consists of goods balance (imports - exports) and it accounts for all tangible items. Services balance includes all intangible items like legal services, technical services, consultancy etc and Income balance includes the interest earned from foreign investments. The capital account consists of “investment transactions” It includes the result of both the financial and non financial assets transactions. The net result obtained from the current account and capital account must be financed by the official foreign reserve. The official foreign reserves account consists of reserve assets in the of foreign ...