The Balance Of Payments 2 Flashcards
Key causes of a current account deficit
- poor price and non-price competitiveness
- strong XR affecting demand for exports and imports
- recession in one or more major trade partner countries
- volatile global prices
How can a strong XR cause a current account deficit
High currency value increases prices of exports. Appreciating currency also makes imports cheaper.
Consequences from a current account deficit
- loss of AD = weaker GDP
- depreciating currency
- inflation
- lack of competitiveness
- financial account surplus
- loss of investor confidence
UK current account balance
Historically high current account deficit - needs to be financed by net inflows on the financial account of the BoP
Policies to reduce a trade (current account) deficit
- demand management
- lower XR
- supply-side improvements
- protectionist measures such as quotas and tariffs
What is an expenditure switching policy
Policies designed to change the relative prices of exports and imports
Example of an expenditure switching policy
An XR depreciation ought to improve the price competitiveness of exports and also make imports more expensive
What is an expenditure reducing policy
Policies designed to lower real incomes and AD and thereby cut demand for imports
Example of expenditure reducing policies
Higher direct taxes and an increase in interest rates
Expenditure switching policy: instrument of a depreciation of the exchange rate
It reduces the relative price of exports & makes imports more expensive
Expenditure switching policy: instrument of import tariffs
It increases the price of imports & makes domestic output more price competitive
Expenditure switching policy: instrument of a low rate of inflation (perhaps deflation)
It keeps general price level under control and makes exports more competitive
Evaluative comment: Expenditure switching policy: instrument of depreciation of the XR
Risk of cost-push inflation - which erodes competitive boost + fall in real incomes
Evaluative comment: Expenditure switching policy: instrument of import tariffs
Risk of retaliation from other countries if import tariffs are used as BoP policy
Evaluative comment: Expenditure switching policy: instrument of low rate inflation (perhaps deflation)
Risks from deflation as a way of achieving internal devaluation - including lower investment
