If the Federal Reserve buys $3 billion worth of Japanese yen,$6 billion of euros,and sells $5 billion of British pounds,how does this affect the balance of payments?
A)Falls by $4 billion
B)Rises by $4 billion
C)Rises by $9 billion
D)Falls by $5 billion

Question

Quizplus · Accepted Answer

When the Federal Reserve buys foreign currencies (in this case, Japanese yen and euros), it is essentially injecting dollars into the foreign exchange market, which increases the supply of dollars. This action is recorded as a debit (a use of funds) in the financial account of the balance of payments. Conversely, when it sells a foreign currency (British pounds in this case), it is taking dollars back in exchange, which decreases the supply of dollars in the foreign exchange market. This action is recorded as a credit (a source of funds) in the financial account. Therefore, buying yen and euros totals $9 billion going out, and selling pounds brings $5 billion in. The net effect is a $4 billion increase in the balance of payments (9 billion out - 5 billion in = 4 billion net outflow, which, in balance of payments terms, is considered a positive increase because it reflects net outflows for currency purchases).

If the Federal Reserve Buys $3 Billion Worth of Japanese