Policies to Improve the Balance of Payments

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    Policies to Improve the Balance of Payments

    • In the short term, measures to improve the balance of payments position tend to focus on the demand-side of the economy
    • In the long term, it’s the supply-side of the economy.

    Short Run

    • There are three main ways the government may try to raise export revenue and/or reduce import expenditure so as to correct the deficit

     

    • Exchange Rate Adjustment
      • This would make the country’s products more price competitive
      • This can be achieved by the central bank selling its own currency or reducing the exchange rate
      • A lower exchange rate will cause export prices to fall and import prices to rise, providing that demand for both is price elastic
      • Lowering the exchange rate should increase AD, and hence raise output in the short-run, but it may increase inflationary pressure.

     

    • Deflationary Demand Management
      • To decreasing spending on imports, a government may implement deflationary fiscal and monetary policy instruments
      • This can be accomplished by higher taxation, lower government spending, or higher interest rates.
      • However, this could decrease output overall and hence increase unemployment.

     

    • Import Restrictions
      • A government can impose tariffs (tax on imports) or quotas (limit on imports) to discourage their consumption
      • Both measures, however, can cause inflation
        • Tariffs will increase the price of products bought in the country, raise the cost of imported raw materials, and reduce competitive pressure for domestic firms to keep costs and prices low.
        • Quotas may also lead to retaliation by other nations, so although it may decrease spending on imports, it may also decrease export revenue
      • Membership of an economic bloc, such as the EU, restricts the extent to which import restrictions can be implemented.

    Long Run

    • If a deficit arises from a lack of quality competitiveness, e.g. low labour productivity or high inflation, then short-run solutions won’t manifest into long run solutions
    • In such a situation, supply side policies are most appropriate.
      • Examples include providing subsidies to small firms in the hope that they’ll become internationally competitive, or increase funding to universities in the hope that they will invent and innovate.
    • How successful the SSPs will be depends upon the appropriateness of the policies, e.g. training has to be in the right area, and small firms must respond appropriately to any incentives
    • SSPs can also be quite costly for a government.

    Current Account Surplus

    • A government may seek to reduce a surplus in order to avoid inflationary pressure and to raise the amount of imports that the economy can enjoy
      • This can be accomplished by:
        • Raising the value of the currency
        • Introducing reflationary fiscal/monetary policies
        • Reducing import restrictions

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