Please enable JavaScript.
Coggle requires JavaScript to display documents.
policies to correct disequilibrium in the balance of payments - Coggle…
policies to correct disequilibrium in the balance of payments
1. Expenditure-Reducing Policies
Definition: Policies aimed at reducing overall demand for goods and services in the economy, thereby reducing demand for imports.
Types of policies:
Contractionary fiscal policy:
Reducing government spending
Increasing taxes
Contractionary monetary policy:
Raising interest rates to discourage borrowing and spending
Effectiveness:
Can reduce demand for imports and improve the current account deficit.
Helps control inflation by reducing aggregate demand.
Limitations:
Can reduce overall economic growth and increase unemployment.
May lead to social discontent due to austerity measures.
Interrelated issues:
Reducing domestic demand may improve the balance of payments but harm growth and employment.
2. Expenditure-Switching Policies
Definition: Policies designed to shift consumer demand from imported goods to domestically produced goods.
Types of policies:
Devaluation/Depreciation of currency:
Makes exports cheaper and imports more expensive.
Tariffs and quotas:
Taxes on imports or limits on the quantity of imports.
Subsidies to domestic industries:
Support to domestic producers to lower costs and make goods more competitive internationally.
Effectiveness:
Devaluation can quickly correct trade imbalances by boosting export competitiveness.
Tariffs and quotas reduce import penetration.
Limitations:
Devaluation may lead to imported inflation (as the cost of imports rises).
Tariffs can provoke retaliatory measures from trading partners (trade wars).
Quotas can lead to shortages of certain goods.
Interrelated issues:
Devaluation can increase inflation, while protectionist measures may lead to inefficiencies and reduced competition.
3. Supply-Side Policies
Definition: Policies aimed at increasing the productivity and competitiveness of domestic industries to improve the balance of payments in the long term.
Types of policies:
Investment in infrastructure:
Improves efficiency in production and transportation.
Education and training:
Increases the skills of the workforce, improving productivity.
Innovation and R&D support:
Encourages technological advances, increasing competitiveness.
Tax incentives for businesses:
Encourages investment and expansion in domestic industries.
Effectiveness:
Long-term improvement in the competitiveness of domestic goods and services.
Can lead to sustainable improvements in the current account.
Limitations:
Takes time to implement and see results.
Can be expensive and lead to higher government debt.
Interrelated issues:
Short-term costs and slow results, but can reduce unemployment and boost long-term growth.
4. Exchange Rate Policy
Definition: Managing the exchange rate to improve the balance of payments.
Types of policies:
Managed float:
Central bank intervenes in the foreign exchange market to influence the value of the currency.
Currency devaluation:
Deliberate reduction in the value of the currency to make exports cheaper and imports more expensive.
Effectiveness:
Can quickly correct a current account deficit by making exports more competitive.
Limitations:
May lead to imported inflation, as the cost of foreign goods increases.
Risk of currency wars if other countries also devalue their currencies.
Interrelated issues:
Devaluation can improve the trade balance but may worsen inflation and harm consumers.
5. Trade Agreements and Liberalization
Definition: Policies aimed at improving trade relations with other countries to boost exports and correct the balance of payments.
Types of policies:
Free trade agreements:
Reducing trade barriers to increase export markets.
Trade liberalization:
Opening up the domestic market to more competition, which can improve efficiency and productivity.
Effectiveness:
Can improve access to foreign markets and boost exports.
Promotes competition and efficiency.
Limitations:
Domestic industries may struggle to compete with foreign firms.
Short-term job losses in less competitive industries.
Interrelated issues:
Can improve the balance of payments but may increase inequality and structural unemployment in uncompetitive sectors.
. Import Controls (Protectionism)
Definition: Policies aimed at reducing imports through government intervention.
Types of policies:
Tariffs: Taxes on imported goods to make them more expensive.
Quotas: Limits on the quantity of certain imports.
Embargoes: Bans on the import of specific goods.
Effectiveness:
Can quickly reduce import levels and improve the balance of payments.
Protects domestic industries from foreign competition.
Limitations:
May lead to retaliation from other countries (trade wars).
Can reduce consumer choice and lead to higher prices domestically.
Interrelated issues:
Can reduce imports and improve the balance of payments but may lead to inefficiencies in domestic industries.