Balance of Payments Model
This model holds that a foreign exchange rate must be at its equilibrium level - the rate which produces a stable current account balance. A nation with a trade deficit will experience reduction in its foreign exchange reserves, which ultimately lowers (depreciates) the value of its currency. The cheaper currency renders the nation's goods (exports) more affordable in the global market place while making imports more expensive. After an intermediate period, imports are forced down and exports rise, thus stabilizing the trade balance and the currency towards equilibrium.
Like PPP, the balance of payments model focuses largely on trade-able goods and services, ignoring the increasing role of global capital flows. In other words, money is not only chasing goods and services, but to a larger extent, financial assets such as stocks and bonds. Their flows go into the capital account item of the balance of payments, thus balancing the deficit in the current account. The increase in capital flows has given rise to the asset market model.
Read more about this topic: Exchange Rate
Famous quotes containing the words balance of, balance and/or model:
““What I want is a strange conjunction with you—” he said quietly; “Mnot meeting and mingling;Myou are quite right:Mbut an equilibrium, a pure balance of two single beings:Mas the stars balance each other.””
—D.H. (David Herbert)
“Not in vain is Ireland pouring itself all over the earth. Divine Providence has a mission for her children to fulfill; though a mission unrecognized by political economists. There is ever a moral balance preserved in the universe, like the vibrations of the pendulum. The Irish, with their glowing hearts and reverent credulity, are needed in this cold age of intellect and skepticism.”
—Lydia M. Child (1802–1880)
“The playing adult steps sideward into another reality; the playing child advances forward to new stages of mastery....Child’s play is the infantile form of the human ability to deal with experience by creating model situations and to master reality by experiment and planning.”
—Erik H. Erikson (20th century)