Consequences of BOP disequilibrium

Question 1

reasons for BOP deficit?
hint: 2

Answer 1

1. current account deficit
2. capital & financial acc deficit

Question 2

impacts of BOP diseqm?
hint: 5

Answer 2

1. dd deficient unemployment & decreased mSOL
   
   • BOP deficit due to fall in (X-M) → AD decreases → slower econ growth → dd deficient unemployment (ST) + lower mSOL (LT)
2. increased mSOL
   
   • current acc deficit → consumers spend more & save less → higher mSOL (ST)
3. impact on exchange rate
   
   • BOP deficit → greater outflow of currency → increased supply of currency → depreciation → IF country operates using fixed exchange rate system: central bank must se foreign reserves to buy excess supply of currency in the foreign exchange mkt to prevent exchange rates from falling
4. decreases consumer & investor confidence
   
   • reserves rapidly run down OR severe/ prolonged BOP deficit → adversely affects C&I confidence → increases unemployment + stifles PEG
5. demand pull inflation
   
   • BOP surplus (due to improvement in current acc) → increased (X-M) → dd pull inflation IF econ is near Yf

Question 3

effects of BOP surplus
*on govt, consumers, & producers

Answer 3

GOVT
1. see-saw: one countries surplus is another countries deficit
- impossible for all countries to run surpluses simultaneously → deficit countries cant cant reduce deficit (unless countries w large surpluses take action to reduce surpluses) → deficit countries may be forced to resort to import controls from all countries, including surplus countries → detrimental to world trade
2. demand pull inflation
- (X-M) increase → AD increase → if econ is near Yf → dd pull inflation
- hot money inflow → increased supply of loanable funds → ir decreases → lower cost of borrowing → C&I increase → econ is near Yf → dd pull inflation

CONSUMER
3. dd pull inflation
- BOP surplus due to (X-M) increase → AD increase → if econ is near Yf → dd pull inflation
4. decrased dd deficient unemployment
- increase (X-M) → increased AD → increased RNY → higher econ activity → lower dd deficient unemployment
5. lower mSOL
- current acc surplus → save more, consume less → lower mSOL (ST)
PRODUCERS
6. econ growth
- increase in FDI (LT cap flow) → I increases → AD increase → RNY increase → higher econ activity → lower dd deficient unemployment increase in Yf → PEG

Question 4

what are the impacts of a trade deficit?
hint: 1 neutral, 1 good, 1 bad

Answer 4

1. not inherently a problem (+ve econ devt → higher lvls of income, C, & I)
2. trade deficit financed by intl cap flows → foreign investors take home dividends, interests, and cap gain they can earn from investments → increased capital supply → lower ir + stimulated job creation
3. growing trade deficit: could signal that that industry is falling behind their foreign counterparts

Question 5

what factors are affected due to BOP surplus/ deficit?
*for govt, consumers, and producers

Answer 5

govt: C&I confidence + exchange rates + macro econ goals (inflation, unemployment, etc)
cons: purchasing power + savings + consumption + SOL
prod: investment & production decisions