Question

Under an international regime of fixed exchange rates, countries with a BOP ________ should consider ________ their currency while countries with a BOP ________ should consider ________ their currency.

Answer 1

Answer:

Under an international regime of fixed exchange rates, countries with a BOP SURPLUS should consider REVALUING their currency while countries with a BOP DEFICIT should consider DEVALUING their currency.

Explanation:

The advantage of a free floating currency exchange is that the balance of payments (BOP) will always be 0. That means that the currency exchange rate automatically adjusts to surpluses by appreciating the currency, while a deficit generates a depreciation of the currency.

When the exchange rate is fixed, several problems can occur, either by having a currency with a lower than normal value, or having a currency with a higher than normal value. The problem with fixed exchange rates is that adjustments aren't smooth and tend to very large and sudden.

We can use Argentina during the 1990s as an example. During more than a decade the Argentinean peso was pegged to the US dollar and it was worth exactly $1 per peso. At the beginning this high value of the peso helped the economy grow and stabilize from a rampant hiperinflation that had depressed the country's economy. So everyone was happy at least for a few years, but then the economy couldn't keep up its growth rate and their exports started to decrease due to high cost of manufacturing. Argentina's exports costed dollars while other Latin countries had costs in local currencies that were worth less than the dollar. Once the BOP's deficit got so large, Argentina had to devaluate its currency form 1 peso per $1, to more than 4 pesos per $1 in just one day.

Answer 2

Answer: surplus, revaluing, deficit, devaluing.

Explanation: Revaluation of a currency is the official increase in value of a currency in relation to a foreign currency in a fixed international exchange rate system.

Therefore a country with a surplus Balance of Payment will have the bargaining power to achieve a revaluation of its currency. This will translate to increase in the BOP of the country because of the increased value of its currency.

However, a devaluation is the decrease in value of a currency, and this is what a country does when it encounters a BOP deficit.