Answer to Question #21201 in Economics of Enterprise for Muhammad Yousuf

Question

In what ways do change in balance of payment and the budget deficit affect the money supply?

Answer 1

Balance of payments is the table of correspondence of foreign income and expenses, which recorded all foreign exchange proceeds received by this country from other countries, as well as all of the funds paid by the country to other countries for a certain period. the sharp increase of positive balance of payments leads to a rapid growth of the money supply and thus stimulates inflation. The sharp increase in the deficit may cause a decline in the exchange rate.
There is an emission way of the financing deficit of the state budget, which is that the government (the Central Bank) increased the money supply, ie issues extra money to help cover its excess of expenditure over income. Advantages of the emission method of financing:
• The growth of the money supply is a factor in increasing aggregate demand and therefore production. The increase in the money supply causes the decrease in the money market interest rate (depreciation of the price of credit), which stimulates investment and ensures the growth of aggregate spending and aggregate output. This measure, therefore, has a stimulating effect on the economy, and can serve as a means out of the recession.
• This is a measure that can be implemented quickly. Money growth occurs, or when the central bank conducts open market operations and buys government securities and paying for sellers (households and firms) value of these securities, issues extra money (so it can make a purchase at any time and in any to the extent necessary), or by direct creation of money (for any amount).
The main disadvantage of the emission method of financing the state budget deficit is that the long-term increase in the money supply leads to inflation, ie inflationary way of financing it.