1. a reduction in the rate of growth of the domestic source component of domestic base money.
2. a devaluation of the domestic currency.
3. a tariff on domestic imports.
4. any of the above.
Choose the option above that is correct.
The right answer is option 1. A balance of payments deficit is a situation where the stock of foreign exchange reserves is declining through time---where ΔR/Δt < 0. A reduction of ΔDsc/Δt will take care of this situation. A devaluation will not cure the deficit because its effect is to produce a one-shot increase in the stock of foreign exchange reserves and there is no reason to believe that it would increase the rate of growth of the demand for base money. A tariff increase would have the same effect as a devaluation, switching world aggregate demand off foreign and onto domestic goods.
The balance of payments deficit equals the excess of the rate of growth of the domestic source component of base money over the rate of growth of the demand for base money. When the government pumps cash into the economy at a slower rate through time via its open market operations in domestic bonds, the public has to reduce its flow of purchases of assets abroad (increase its flow of sales) to maintain the desired rate of growth of its money holdings and thereby continually maintain portfolio equilibrium This will reduce the rate at which the government has to sell foreign exchange reserves to maintain the fixed exchange rate. A devaluation increases the level of output or prices and hence the desired stock of money but does not necessarily increase the rate of change of the desired stock of money. As a result, it has no effect on the rate of change of the stock of official reserves through time.