THEME 4 Flashcards
What is the current account
-balance of trade in goods
-balance of trade in services
-net primary income (income from interest and profits)
-net secondary income (contributions to military aid)
What are the other accounts except the current account
financial account and capital account
structural causes of current account deficit
- under-investment
-low productivity
-persistently high inflation
cyclical causes of current account deficit
-boom in domestic demand
-over valued exchange rate
-increased demand for imported technology
if you have a current account deficit, what must you also have
a financial account surplus
In short terms what is the main objective
increase exports and reduce imports
What is deflationary policy
using tight fiscal and monetary policy in order to cause exports to increase and imports to decrease
(deflationary policy) how does tight fiscal policy work for reducing imports
High tax, low government spending. Less imports as this cuts spending. Uk imports highly inelastic though so it might not work. food and fuel
(deflationary policy) how does tight fiscal policy work for increasing exports
Does not directly cause high exports. It could cause lower inflation which makes exporting cheaper. However, there is no guarantee that other countries will want our exports due to non price competition.
(deflationary policy) how does tight monetary policy work for reducing imports
high interest rates. low credit availability. QE will be stopped and QT might be introduced.
demand will drop as interest rates rise so people save which will decrease the amount of imports.
(deflationary policy) how does tight monetary policy work for increasing exports
In theory inflation should drop making exports increase by becoming cheaper. However, interest rates cause SPICED and exports could become more expensive due to the exchange rate getting stronger. (as hot money comes in, imports become cheaper and exports become more expensive)
Name some supply side policies as a deficit removal policy
subsidies more production (decrease costs and increase technology)
-decrease coorporation tax (businesses keep profit and can re invest more)
-increase spending for education (better opportunities leading to more production)
-increase minimum wage (more incentive to take a job)
-improve infrastructure
-work on training / apprenticeships
Eval of supply side policies
Time lag in making new industries. Absolute and comparative advantage but they only occur in a free market.
What is a potential problem for supply side policies
If current account deficit as a percentage of gdp is greater than percentage of gdp growth then there is a problem
4 areas of protectionism
-quota - limit account you can bring in
-tariff - tax on imports
-embargo - complete ban on imports
-subsidise the domestic industry - reducing cost of production within domestic industries
Evaluation of protectionism
- retaliation (other countries will do it back)
- non price competition (maybe replace imports)
- inflationary pressure due to tax on imports which is cost push inflation
what is the main objective for exchange rate policy
to weaken the exchange rate
3 main changes when performing exchange rate policy
- Lower interest rates
- increase money supply
- sell domestic currency reserves
(exchange rate policy) evaluative points of lowering interest rates and increasing money supply for exchange rate policies
-imports are inelastic
-non price competition
-liquidity trap
-depends on other countries exchange rates
(exchange rate policy) what does it mean by selling domestic currency reserves
sell your currency and buy others. Increases demand for the currency you buy and increases supply of the currency you sell.
(exchange rate policy) evaluative point of selling domestic currency reserves
run out of your own money
what is the MARSHALL LERNER CONDITION
depreciation of the currency will only work if the combined elasticities of imports and exports are greater than 1
j curve
check book
what does the j curve show
it shows time lags between a falling currency and an improved trade balance
what could a current account deficit lead to
-structural weakness
-unbalanced economy
-loss of output and employment
-downward exchange rate policy
what is a floating exchange rate
a countries exchange rate where currency price is determined by supply and demand of other currencies
benefits of a floating exchange rate
-stability in the balance of payments
-foreign exchange is unrestricted
-central bank has less need for power so there is more independence
drawbacks of a floating exchange rate
-exchange rate volatility
-currency risk
fixed exchange rate
you set the value but it is only fixed towards other fixed exchange rates. (if you have to adjust it then it is revalue and devalue)
benefits of fixed exchange rate
-smooth flow of money from 1 country to another
-helps smaller countries avoid devaluation of their currency
-less developed countries attract foreign investment
drawbacks of fixed exchange rate
-lack of flexibility
-balance of payments issues
-dependence on reserves
managed floating
manipulate the exchange rate to benefit the countries specific needs. benefits of both in theory
disadvantages of managed floating
- removes option for the government to use currency to improve international trade and competitiveness
- may be volatile in markets inhibiting the trade
