policies to correct imbalances in the current account of the balance of payments chapter 29 Flashcards
how does a country not get into international debts
if export revenue equals import expenditure, the country will not get into international debt. it will not be giving up the opportunity to buy foreign products it can afford
why may governments welcome more being spent on imports than earned from exports in the short run
this arises from more raw materials and capital goods being imported. a deficit also allows a country to consume more goods and services than it is producing
why may government encourage a surplus of export revenue over import expenditure
to boost AD and to provide funds to repay external debt
how may a country use contractionary fiscal policy to reduce a deficit on the current account of its balance of payments
to reduce demand for goods and services including imports it can increase income tax and reduce government spending
what happens when there is a rise in income tax
A rise in income tax will reduce disposable income, leaving less income for households to spend on imports as well as products produced by domestic firms.
what happens when governments reduces spending
Lower government spending will directly reduce demand for goods and services which may reduce imports and put pressure on domestic firms to increase their exports.
how may a government reduce a current account surplus by using expansionary fiscal policy
Lower income tax and higher government spending on, for instance, state pensions will increase consumer expenditure More imports will be purchased and some products may be diverted from the export market to the home market.
why are changes in current account position caused by fiscal policy measure short term and not long term
this is because once the policy measures are stopped, households and firms are likely to go back to spending the same amount on imports relative to the amount of export revenue earned.
adverse effects of raising tax
Raising taxes may also have adverse side effects. They lower demand, which may increase unemployment and slow economic growth. Higher taxation can also create disincentive effects and so may reduce aggregate supply.
what can reduce the growth in spending on imports
reducing the growth of the money supply
what happens when an economy has a low rate of inflation and a current account deficit
its central bank may reduce the interest rate in an attempt to put downward pressure on a floating exchange rate.
what can be caused by a lower interest rate
A lower exchange rate may result in the country’s products becoming more internationally competitive, but there is a risk it may generate inflationary pressure.
what can be caused by a higher interest rate
higher interest rate may act as a way of cutting consumer expenditure, reducing demand for imports and reducing inflationary pressure. It may, however, raise a floating exchange rate that could reverse the fall in demand for imports.
how can a government increase consumer expenditure to reduce current account surplus
it can be done by using monetary policy. In this case, it may raise the money supply and cut the rate of interest. It might also try to encourage an appreciation of the exchange rate.
why are most monetary policy not likely to be effective in reducing imbalances in the current account of the balance of payments in the long term
This is because they are unlikely to be tackling the structural weaknesses in the economy, such as low productivity, which are causing a current account deficit. They may also not have any long- term effect on structural strengths, such as a high rate of innovation and ownership of scarce raw materials, which are causing a current account surplus.
how can supply side policy tools may reduce a current account deficit
by making domestic markets more attractive to invest in.
For instance, deregulation and privatization may increase the competitive pressure on domestic firms to keep costs and prices low, to improve quality and to become more responsive to changes in consumer demand.
how can increased spending on education and training and increased investment subsidies increase exports.
A more skilled labour force and better capital equipment may reduce the relative price of domestic output and raise its quality. Both of these effects will be likely to increase domestic firms’ share of the home market and the international market.
impact of skillful workforce and good quality equipment
A skilful labour force and good-quality capital equipment may also attract foreign multinational companies (MNCs) to set up a local branch in the country in expectation they will be able to produce good-quality products at low cost. Such multinational companies may contribute to the country’s exports.
how can trade unions help domestic firms
may enable domestic firms to work with more flexibility and so be more responsive to changes in demand. A resulting fall in industrial action combined with greater flexibility may make foreign firms more willing to buy the country’s exports.
disadvantages of using supply side policy to correct imbalances in current account of the balance of payments
Supply-side policy is unlikely to be a quick way of correcting imbalances in the current account of the balance of payments. It is also not designed to reduce a current account surplus as it seeks to increase the quantity and quality of the country’s resources. It does, however, have the potential to correct a deficit in the current account in the long run.
effect of protectionist policy on the current account
Protectionist policy can be used as a way of encouraging domestic consumers and firms to switch to buying domestic products. However, imposing tariffs against trading partners in a trade bloc is not an option. Imposing or increasing tariffs against other countries involves two risks.
risk of imposing or increasing tariffs against other countries
One is that it may provoke retaliation and the other is that it may reduce the pressure on domestic firms to become more efficient.
