Global financial market

1) How can a Persistent USA Balance of Payment Deficit Stimulate World Inflation?
From an economic point of view, the balance of payments refers to the record where all
the financial transactions and international trade conducted by a country are recorded. Ideally,
the balance of payments comprises three components namely; capital account, financial account,
and current account. The combination of these accounts determines whether a country has a
surplus or a deficit balance of payments (Stern, 2007). For the purpose of this paper, the main
consideration is to evaluate how a persistent deficit in the balance of payment in the USA
stimulate inflation in the world. A deficit in a balance of payment refers to a case where a
country imports more goods, services, and capital than the value of goods, services, and capital
exported.

In the United States of America, the deficit on balance has been persistent thereby
stimulating world inflation in several ways. Ideally, the US borrows from other countries to fuel
its imports and to fuel economic growth in the short-term. The balance of payment deficit in line
with the current account deficit reduces the level of economic growth especially if the deficit is
persistent. During a balance of payment deficit in the US financial systems, the foreign lender
aims to gain an adequate return on investment (Stern, 2007). Thus, a decrease in demand causes
the value of the US Dollar to decrease thereby causing inflation due to the increase in import
prices. Moreover, world inflation tends to increase because inflation in the US translates to
World inflation due to fluctuations in foreign exchange rates.
In 2006, the balance of payment deficit reached a record $900-$950 billion. The deficit
created major issues in economic sustainability due to disequilibrium in the balance of payment
deficit. The persistent deficit resulted in inflation throughout the economic period of recession.

The main cause of deficit on the balance of payment in the US in 2006 was huge international
borrowing. From an economic point of view, a country that tends to borrow heavily from other
countries is likely to have a deficit balance of payment (Stern, 2007). On the other hand, the
lending country tends to a surplus or favorable balance of payment. During the economic
recession in the US, the country borrowed excessively from other countries thereby causing a
deficit in the balance of payment. During that period, Americans could not cut back on credit
card spending.
Besides, Americans could not increase their saving rate sufficiently to fund domestic
economic growth. These issues lowered the standard of living, increased interest rates, and
stimulated inflation in the world (United States Congress et al., 2018). Generally, there are
several countries in the world that use the US Dollar in business transactions. Therefore, a
persistent deficit in the balance of payment in the US causes a decline in the value of US
currency. This cause inflation in the US and other countries depending on the US dollar along
with the fluctuation of foreign exchange. Besides, the inflation created by the deficit in the
balance of payment results in an increase in interest rates that stimulation inflationary gaps in the
world.
Moreover, a persistent balance of payment deficit in the US stimulates world inflation
because the US is rated as the top importer in the world. For example, the balance of trade deficit
is associated with the over-reliance of the US in foreign oil (United States Congress et al., 2018).
In other words, an increase in the prices of oils translates to a deficit in the balance of payment.
Thus, the US release a lot of capital to fuel imported goods and services. This causes too much
money in the economy of the exporter thereby creating an inflationary gap. In other words, a
persistent balance of payment deficit in the US stimulates inflation in the domestic economy thereby making the foreign goods to be relatively cheaper as compares to domestic goods. In the
long run, imports increase thereby increasing the persistence of balance of payment deficit and
inflation simultaneously.
Overall, the US government has seen how persistent balance of payment deficit has
stimulated the level of inflation in the world. Primarily, the US has initiated several programs to
correct the deficit through the intervention of the Congressional Budget Office (United States
Congress et al., 2018). The US has advised its citizens to cut back on credit card spending, to
increase their saving rate to enhance domestic business growth. The US government has reduced
spending on imports and has promoted domestic business. These solutions have corrected
balance of payment deficit thereby managing inflationary gaps in the world.
2) How can the IMF Limit Moral Hazard?

From international financial standards perspective, moral hazard refers to risk-taking
where one party in a business transaction takes financial risks. Essentially, the party taking risks
is aware that another party will suffer financial consequences in case the agreement fails to
materialize. From an economic point of view, moral hazard takes place when one party increases
its exposure to risk when insured simply because another party bears the cost of the risk
(International Monetary Fund, 2013). In that connection, the International Monetary Fund (IMF)
uses several strategies to limit moral hazard. Some of the strategies used by IMF includes;
formation of regulations to monitor transactions, use of incentives, and use of policies to prevent
immoral behavior in financial systems.
First, moral hazards can affect the party bearing the cost of risks in case term of
engagement are violated. Thus, the IMDF maintain that all the economic impacts would worsen
in the absence of IMF’s supporter. In other words, finances offered by the IMF limits financial crises from getting harmful. The IMF provides financial aid to interested parties in the form of
incentives. This strategy is essential because currencies provided by IMF prevent any form of
financial crises if a moral hazard occurs (International Monetary Fund, 2013). Besides, the IMF
and its supporters provide essential solutions to limit the moral hazard through the provision of
much-needed liquidity. Thus, a country exposed to moral hazard and financial crises can use
IMF as a platform to minimized risks taken by parties involved. Moral hazard is created by
private international lenders who charge high rates of interests. Thus, a country in a financial
crisis may find its self in a moral hazard as it tries to borrow at high rates of interest. Thus, the
IMF prevents moral hazard from occurring because the majority of private international lenders
would not provide finances to a country in financial crisis at normal interest rates. Ideally, the
rates of interest for IMF funding are lower than the rate charged by private lenders.
Moreover, IMF limits moral hazard by helping crisis country to make the payment on its
imports and debts even if the foreign currency reserves are depleted. More importantly, the IMF
limits moral hazard by reducing the spread on sovereign bonds and debt instruments of a
country. This policy is used to reduce the risk of default of a country thus limiting moral hazard.
Besides, the IMF is essential in stabilizing the international financial systems via moral hazard
prevention, crises prevention, and mitigation (Copelovitch, 2010). Conversely, the IMF limits
moral hazard using IMF Surveillance Program, information provision, and technical assistance.
These policies are essential towards limiting moral hazard and prevention of crises. Mainly, IMF
is the leading supporter of financial adjustments in countries facing currency and financial crises.
Thus, adjustment programs used by IMF limit moral hazard by mitigating risks involved in
financial borrowing and lending.

Moreover, the IMF has emphasized on the importance of ensuring timely surveillance of
terms of the contract between parties involved to make them understand the level of risks
involved in a contract. For example, IMF require parties involved in market developments to
report regularly to the Executive Board. Thus, IMF can monitor the level of morality in business
thereby limiting moral hazard. The IMF Funds surveillance program has be used to limit moral
hazard in Thailand by warning the government on risks of excess borrowing at high interest rates
thereby increasing the probability of a crisis (Copelovitch, 2010). More importantly, the IMF
offers technical assistance to its members in terms of strategies to limit moral hazards.
Overall, the IMF propels its member countries to strengthen their economic and financial
systems, monetary policies, exchange rates system, and the tax system. If countries can empower
these systems, then fewer risks would be involved when engaging in financial agreements
thereby limiting moral hazard. The IMF uses extensive publication of statistics to limit moral
hazards especially via the Data Standards Bulletin Board that empowers the ability of the
markets to operate freely and effectively. Lastly, the IMF propels different financial sectors to
take rigorous adjustment measures that aim to limit moral hazard. Overall, the role of the IMF in
limiting moral hazard is spelled out in the Article of Agreement that provides confidence to
members by creating opportunities correct moral hazard and maladjustments.

References

Copelovitch, M.S. (2010). The International Monetary Fund in the Global Economy: Banks,
Bonds, and Bailouts. Cambridge University Press.
International Monetary Fund. (2013).The Role of the IMF as Trusted Advisor. Intl Monetary
Fund.
Stern, R.M. (2007). Balance of Payments: Theory and Economic Policy. Aldine Transaction.
United States Congress. Committee on Banking. & United States Senate. (2018). Risks of a
growing balance of payments deficit. CreateSpace Independent Publishing Platform.