I am a beginner economics student and recently, I have been learning about how balance of payments surpluses are important for a country to control the value of its currency using its accumulated foreign reserves. In the case of the free floating exchange rate regimes (e.g. Russia), by default, the foreign reserves account is empty. This makes perfect sense since the country does not need any reserve assets to manipulate the value of the currency. Does that mean to say that the balance of payments position is always "neutral" (i.e. neither deficit nor surplus) for a country with a freely-floating exchange rate regime and that the BOP position is irrelevant for such a country since the current account and capital and financial accounts automatically balance each other?
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$\begingroup$ I feel like I am having some misconceptions. But I'm not sure what misconceptions I have... Would be great if someone could help me out. $\endgroup$– Tan Yong BoonCommented Mar 3, 2019 at 11:46
1 Answer
The Balance of Payments are a form of double-entry bookkeeping and so in theory should always balance overall
If official reserves do not change because the currency is floating freely and the Central Bank or Treasury is not intervenening, then a country's current account balance should be offset exactly by the financial/capital account balance. But measuring this is difficult, which is why you often see a "statistical discrepancy", for example in row 100 of page 10 of the US Balance of Payments
But the individual flows matter, and it might then be wrong to say "the BOP position is irrelevant", at least in the medium to long term. A country with a persistent current account deficit will need to see net inward financial flows, which may be desirable if it leads to increased real investment and later to increased output, but may be less desirable if it merely leads to greater indebtedness and the need to pay for that debt
Meanwhile a country with a persistent current account surplus is effectively continually exporting more than it needs to pay for imports, so reducing its consumption and standard of living; this may make sense if it later intends to increase consumption with the income from its investments abroad, but otherwise is unnecessary and potentially wasteful and can lead to a failure of these unbalanced investments, as happened with German banks' speculative assets in the USA during the financial crisis
