Question

Answer all of them or do not answer

Q8. Why does balance of payment always balance even when balance of trade may not be in balance? How does the US government pay for its chronic trade deficit of over $400 billion per year for so many years? Does this trade deficit matter in the long run? 09. How can monetary policy actions reduce the trade deficit? How might the increase in budget deficit from expansionary fiscal policy increase the trade deficit?

Answer 1

Since the balance of payment is based upon the system of double-entry book-keeping, the total debits must equal to total credits. This is because two aspects of each transaction recorded are equal in amount but appear on opposite sides of the balance of payments account. In this accounting sense, balances of payments for a country must always balance. The debit side shows the use of total foreign exchange acquired in a particular period. The credit side shows the sources from which the foreign exchange is acquired during a particular period. Against every credit entry, there is an offsetting debit entry & vise-versa, so the receipts and payments on these two sides must be equal. Hence the two sides must necessarily balance. If X imports from Y, Y would also import from X. Hence there would be a debit and credit entries in the balance of payments of both the countries X & Y. The individual items in the balance of payments may not balance. But the total credits of the country must be equals to its total debts. If there is any deficit in an individual account, it would be covered by a surplus in other accounts, if there is any difference between total debits and total credits, it would be settled under 'errors & omissions'. Hence in the accounting sense, the balance of payments of a country always balances. But, the balance of trade of a country may not balance. For instance, if exports exceed imports, there is a surplus and a favorable balance of trade and vice-versa. Only if the value of exports is equal to the value of imports, the balance of trade is said to be in equilibrium.