Discuss the interrelationship between the exchange rate regime and Essay

Discuss the interrelationship between the exchange rate regime and viability of the alternative approaches to resolving a balanc - Essay Example Since balance of payments accounts have to be balanced therefore a change in the exchange rate between the domestic and foreign currencies can actually create the balance. In order to re-balance the accounts the overall adjustment in the exchange rate regime of the country can play significant role. Thus equilibrium in balance of payments accounts could be achieved through subsequent adjustment of the exchange rates in the economy. There are however, different approaches underlying the balance of payments and it’s interlinking with the exchange rate regimes. The traditional analyses through IS-LM framework, monetarist approach as well as structural approaches are the key economic analysis frameworks underlying the issue of balance of payments. This paper will therefore attempt to discuss and explore the exchange rate regimes and the viability of the alternative approaches to resolve the balance of payments issues faced by the economies over the period of time. Balance of Payme nts and Exchange Rates Before discussing alternative approaches and their viability in resolving the balance of payment issues, it is critical to discus and set the theoretical foundations of the balance of payments and it’s interlinking with exchange rate regimes. ... The overall purpose is to keep the record of the flow of goods, services and capital moving to and from the country.( Krugman & Obstfeld, 2009) There are two parts of the balance of payments accounts i.e. current and capital account and both sum to zero at the end of period. Current account shows all the trade and factor income includes exports, imports whereas the factor income side includes both the payments and the earnings. The capital account however records the changes in the capital asset base of a country thus the changes in the assets of the country take place when domestic and foreign assets of the country change hands. It is also argued that the major changes in the balance of payments arise due to the changes in the capital account. (Beko ,2003). It is the movement in the capital that potentially explains the changes which take place in the balance of payment as well as the exchange rate of a country. Balance of payments Crisis Balance of payment however, can become a sig nificant issue as at the macroeconomic level, it tends to create important political implications. Balance of payments crisis can emerge when a country is actually unable to pay for its essential imports or cannot service its debt comfortably. This normally occurs owing to the changes in the exchange rate of a country which can register a sharp decline in value during the crisis.( Hallwood & MacDonald, 2000). Apparently such crisis emerge when countries initially experience heavy capital inflows however, after a certain point, considering the overall risk associated with the international debt, investors tend to withdraw their capital in haste thus putting pressure not only on the balance of payments accounts of a country but also on its exchange rate. Capital outflows in