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SETTLEMENT CONCEPT

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Abhijeet S
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SETTLEMENT CONCEPT - September 13th, 2010

THE OFFICIAL SETTLEMENT CONCEPT

An alternative approach for indicating, a deficit or surplus in the BOP is to consider the net monetary transfer that has been made by the monetary authorities is positive or negative, which is the so called – settlement concept.


If the net transfer is negative (i.e. there is an outflow) then the BOP is said to be in deficit, but if there is an inflow then it is surplus. The basic premise is that the monetary authorities are the ultimate financers of any deficit in the balance of payments (or the recipients of any surplus).


These official settlements are thus seemed as the accommodating item, all other being autonomous.

The monetary authorities may finance a deficit by depleting their reserves of foreign currencies, by borrowing from the IMF or by borrowing from other foreign monetary authorities. The later source is of particular importance when other monetary authorities hold the domestic currency as a part of their own reserves.


A country whose currency is used as a reserve currency (such as the dollars of US) may be able to run a deficit in its balance of payments without either depleting its own reserves or borrowing from the IMF since the foreign authorities might be ready to purchase that currency and add it to its own reserves.


The settlements approach is more relevant under a system of pegged exchange rates than when the exchange rates are floating.
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