E+D Economies - Foreign Currency Gaps

Question 1

What is a foreign currency gap?

Answer 1

• When the amount of foreign currency in a country decreases
• Mainly due to current account deficit - net imports greater than net exports

Question 2

Constrains because…

Answer 2

• If country has foreign currency gap, it will need to exchange currency on the currency market
• ^^ if demand for Lebanese exports is low, demand for the Lebanese pound will be low
• ^^ if it wants imports, need to sell domestic currency - depreciate Lebanese pound further
• ^^ import prices increase - SRAS shifts inwards - cost-push inflation - reduce output - economic slowdown - FDI limited - slower economic growth/development

Question 3

Fix

Answer 3

• Ethiopia managed to do so
• ^^ used to only produce coffee but diversified
• ^^^^ helped new industries to develop by not taxing new companies for five years and apply schemes to encourage FDI
• Diversification - when a country increases the amount of different exports it offers
• Demand for Ethiopian currency - increase demand for exports - Ethiopia currency appreciation - foreign currency gap reduced - decrease price imports - decrease inflationary pressure

Question 4

Eval

Answer 4

• However, the impacts of diversification on the foreign currency gap will only be seen in the long run
• Short run - consumers still face expensive imports and inflation
• Government would also suffer due to lots of government spending and little tax revenue - increase budget deficit and national debt