Policies to mitigate BOP diseqm

Question 1

what are the 2 ways a persistent BOT deficit is fixed?

Answer 1

1. expenditure reducing effect (cut expenditure)
2. expenditure switching effect (increase C, decrease M)

Question 2

how does contractionary fiscal policy correct BOT deficits?

Answer 2

contractionary FP: decrease G, increase direct T → decrease AD → multiplied decrease of RNY → decreased purchasing power → decreased Mexp → (X-M) increases (assuming X remains unchanged) → BOT deficit decreases
(expenditure reducing)
*note: cannot use AD/AS diagram to show reduction in BOT deficit

Question 3

how does contractionary ir policy correct BOT deficits?

Answer 3

increased ir → higher cost of borrowing & returns of savings → decreased C&I → decreased AD multiplied decrease of RNY → decreased spending on M
(expenditure reducing)

Question 4

how does expenditure switching work?

Answer 4

assume consumers can choose to consume domestic g&s or imported ones (XED>1)
- decrease AD → decreases GPL → fall in domestic inflation rate relative to competitor countries → buys more domestic goods ++ cheaper exports → Xrev increase, mexp decrease → BOT deficit reduced

Question 5

use SUUNART to evaluate the e contractionary demand management polices

Answer 5

1. state of economy
   
   • decreased AD → multiplied fall in RNY → decreased EG and increased unemployment → may lead to economic recession
   • if econ faces both BOT deficit and cyclical unemployment → should target expenditure switching not reducing
2. unintended consequences
   
   • contractionary policy → decrease M from other countries → decreased AD and RNY for other countries → decreases their own M (due to intl multiplier) → -vely affects others countries
3. nature of economy
   
   • SOE → small effect bc of small k (small MPM & MPS in sg)
4. root cause
   
   • root cause: loss of X price competitiveness & non-price competitiveness (qlty)
   • contractionary dd mgmt polices only targets M, not X
   • to target Px: depreciation & SSP
5. time
   
   • should only be done in ST, bc it doesnt address root cause
   • exchange rate policy & SSP are better in improving X competitiveness

Question 6

fiscal & ir policies to correct BOT surplus?

Answer 6

opposite of deficit :))

Question 7

how does exchange rate policy correct BOT deficit?

Answer 7

free floating exchange rate: automatically corrects exchange rate imbalances
[imbalances are only faced w fixed/ managed float]

depreciation → fall in external value of currency → fall in Px of foreign country → increased Pm in domestic currency
- expenditure switching: locals switch to consuming domestic products (decrease QDm) → QDx increase → assuming PEDx & PEDm > 1, net Xrev icnreases
- for sg: from appreciation to zero appreciation → signals depreciation (but never call it depreciation for sg!!)