6.5 Policies to correct imbalances in the current account of the BOP Flashcards
How do you use fiscal policy to correct CA imbalance?
If there is a CA deficit, income tax would be increased. This will reduce the amount of disposable income, which will reduce the quantity of imports. However, it might also affect domestic goods as they have less money to spend on domestic goods too.
Govs could reduce their spending. This would reduce AD and lead to less imports. It forces domestic firms into increasing exports which helps improve the disequilibrium
What are the problems with using fiscal policy to correct CA imbalance?
Fiscal policy is effective in the short run, but not so much in the long run. As soon as the policy measures end, households are likely to go back to spending on imports
Govs might have imperfect info on the economy so it could lead to gov failure
If taxes are imposed on trading partners, it could lead to retaliation which will reduce demands for exports
How do you use monetary policy to correct CA imbalance?
Expenditure-reducing policy is when they aim to reduce demand in the economy, so spending on imports fall
Expenditure switching policy is when they aim to switch consumer spending towards domestic goods and away from imports
Reducing the supply of money in the economy can be both. If there is a deficit, the bank might lower interest rates to cause depreciation in the currency. This causes exports to become cheaper. However, there will be hot money flow out of the country as investors are not receiving a high return. There is also a significant time lag
How do you use Supply side policies to correct CA imbalance?
They can help increase productivity with increased spending on education and training which makes the country more internationally competitive. This could lead to a rise in exports. However, this incurs a significant time lag, so it is not effective as an immediate measure.
SSPs could help make the domestic economy attractive to investors
The domestic economy can be made more competitive through deregulation and privatisation which will force firms to lower their average costs. However, it could lead to monopolies being formed which wont increase efficiency
