Skip to main content

Macroeconomics: imbalances in the balance of payments

  • Current account deficit: 
    • this will cause a currency depreciation, as the demand for imported goods is bigger than the foreign demand for exported goods. This will make it easier for domestic producer to exports their goods as they, the goods, become relatively cheaper on the foreign market.
    • A deficit in the balance of trade implies that the financial account must be positive (remember Xn= S-I). In order to pay for the imported goods, it must be the case that foreign entities own more domestic financial assets. Furthermore, foreign countries will buy domestic government debt.
    • The central bank can try to offset inflation by raising the interest rate which can then attract foreign capital (i.e money). However, in the short term, this will be a monetary contractionary policy.
  • Current account surplus:
    • The domestic currency will appreciate, since foreign demand for exported goods is bigger than the domestic demand for imported goods. Note that domestic savings are then used to finance foreign consumption.
    • Stronger currency implies that people can more easily import foreign goods as they are relatively cheaper.
    • If a nation heavly relies on exports, a strong currency may have an decrease the standard of living of the country's domestic consumers.
  • Methods for correcting imbalance in the balance of payments: 
    • exchange rate intervention: to correct a trade deficit, the government wants to devalue its currency in order to make its export more attractive to foreign consumers. To correct a trade surplus, a government needs to appreciate its currency, in order to make its export more expensive. 
    • Note that naturally, a current account balance, overtime, moves toward 0 (i.e it is balanced). This is due to the exchange rate responding to the difference between the demand for imported and exported goods.
    • Monetary policies: contractionary policies (i.e raise interest rate) aims to appreciate a country's currency whereas an expansionary policy (i.e lowering interest rate) aims to depreciate the domestic currency.
    • Protectionist policies (tariffs, quotas, and subsidies): these policies aims at promoting domestic industries, thereby reducing reliance on imported foreign products. This method is usually implement in order to obtain a trade balance surplus.
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 246-250.

Labels:
Location: Boston, MA, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: real vs nominal gross domestic product

Nominal GDP:   A nominal GDP measures the value of a nation's output produced in a year, given the prices charged for that year. However, if prices increase while the output level stays constant in a given year, the nominal GDP will drastically increase, even though the level of production is equal to that of the previous year. Estimating real GDP: To determine the actual change in output from one year to the next, we must adjust the nominal value of a country's output in a year based on changes in the average price level during that year.  Inflation is when the price level increases, whereas deflation is when the price level is decreasing. To determine whether the nominal GDP overestimates or underestimates the output of a country, one must know whether the average price level has increased or decreased. In order to achieve this task can use a price index known as the GDP deflator. The GDP deflator: Real GDP is calculated by replacing the prices for that current year with tho...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Macroeconomics: the money market and loanable funds market

  The money market: The money market combines the supply of money and the demand for money for a country. The supply curve (Sm) is inelastic and is determined by the central bank. The demand curve (Dm) is the horizontal summation of the asset and transaction demand curves and is sloping downward. The intersection between the Sm and Dm is the equilibrium interest rate for a country. A change in the nominal interest rate implies that either or both curves (i.e Sm and Dm) have shifted to the right or left. An increase in nominal GDP (P*Y) will lead to an increase in the transaction demand for money which will shift the total demand (Dm) to the right. The nominal interest rate goes up. A decrease in the level of output (Y) will shift the Dm curve to the left. The Sm curve will shift whenever the central bank decides to change the money supply due to a monetary policy decision. The Fed expands the supply of excess reserves in commercial banks, by purchasing bonds from banks, Sm shi...
Post a Comment
Read more