policies to reduce a balance of Payments Deficit

Topics: Inflation, International trade, Supply and demand Pages: 2 (387 words) Published: April 9, 2011
policies to reduce a balance of Payments Deficit
1. Devaluation.
This involves lowering the value of the currency against others. · If there is a devaluation in the currency the price of importing French goods increases and therefore the quantity demanded falls. · Exports will be cheaper in price for the French and will increase the quantity of exports · Therefore we would expect a devaluation to lead to an improvement in the current account. However it does depend upon the elasticity of demand for exports and imports. The Marshall Learner Condition

This states that a devaluation will improve the balance on the current account, on the condition that the combined elasticity’s of demand for imports and exports is greater than one. · If (PED x + PED m > 1) then a devaluation will improve current account · If (PED x + PED m > 1) then an appreciation will worsen current account · This is because the effect on the current account depends on the total value and not just the quantity of exports. The J Curve effect

In short term demand for imports and exports tends to be inelastic. Therefore current account tends to get worse before it gets better. · Another problem with devaluation is that it can lead to imported inflation. This is a problem if it leads to cost push inflation. This means the improvement in the current account might only be temporary. 2. Deflation

If govt reduces AD by raising interest rates or increasing taxes then people will have less money to spend so they reduce consumption of imports. · The UK has a high mpm therefore a reduction in AD improves the current account significantly · Deflationary policies will also put pressure on manufacturers to reduce costs and this will lead to more competitive exports and so exports will increase · The success of this policy depends on the elasticity of demand for imports · However this policy will conflict with other macroeconomic objectives With lower AD, growth is likely to fall causing higher...
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