Test A – Question 6

The economy’s foreign exchange reserves increased.

1. State two possible reasons for the increase in foreign exchange reserves.
2. Show how the increase in foreign exchange reserves, as a result of one of the reasons you mentioned, would be reflected in a balance of payments diagram.

answer:

The economy’s foreign exchange reserves can increase (among other things) as a result of the following reasons:

1. Increase in exports of goods from Israel abroad.
2. An increase in grants transferred by the US government to Israel.

As a result of each of these items, foreign exchange enters the country, and if the total foreign exchange entering the country in a particular year is greater than the total foreign exchange leaving the country, then in that year there was an increase in the economy’s foreign exchange reserves.

1. Below is a diagram of the balance of payments (in billions of dollars) before and after the increase in exports of goods from Israel:

Explanation : In each of the balance sheet items (except item C), when foreign exchange enters the country, the amount is marked with a “+” and when foreign exchange leaves the country, the amount is marked with a “-“.

Section C indicates the changes in “net reserve inflows,” which are in fact the country’s foreign exchange reserves. The change in the country’s foreign exchange reserves is supposed to balance the other items in the balance of payments.

• When the country’s foreign exchange reserves increase by a certain amount, this amount will be marked in section C with a “-“.
• When the country’s foreign exchange reserves are less than a certain amount, this amount will be marked in section C with a “+”.

Before the increase in exports: It can be seen that there is a deficit of $0.9 billion in the balance of payments (the sum of items A+B was -0.9). This means that more foreign exchange left the economy. As a result, the country’s foreign exchange reserves decreased by $0.9 billion during that period.

After the increase in exports: Due to the increase in exports, there was a surplus in the balance of payments of $19.1 billion. (The sum of items A+B is +19.1). Therefore , the country’s foreign exchange reserves increased by $19.1 billion during that period.

Note: In the current question, we will assume that section D (“Statistical differences”) always resets to zero, meaning that there are no measurement problems, data inconsistencies, etc.