Balance of payments problems
The balance of payments can cause problems for policy makers when there is either, a persistent deficit, or persistent surplus in one part of the Balance of payments.
A large deficit (or even surplus) may need policies developed to correct it - particularly in the medium to long term. To a large extent, the growth of imports and exports will depend on the levels of economic growth domestically and overseas. Factors which influence changes in demand for exports and imports are as follows:
- Domestic economic growth will lead to a higher level of imports. The rate of growth of imports will depend on the income elasticity of demand for imports. An income elastic demand for imports will mean that imports grow faster than GDP. This will tend to lead to a balance of payments deficit.
- Economic growth in the rest of the world will lead to a higher level of exports. The rate of growth of exports will depend on the income elasticity of demand for exports. An income elastic demand for exports will mean that exports grow faster than GDP. This will help to prevent a balance of payments deficit.
- Changes in demand for exports and imports in response to price changes will depend upon the price elasticities of demand. The more price elastic is demand, the greater will be the responsiveness to any price change.
Therefore, the change in a country's balance of payments will depend on:
- The difference between the price elasticity of demand for exports and the price elasticity of demand for imports, and the rate of economic growth in that country compared to the rest of the world (and particularly its trading partners).
- The price competitiveness of that country's exports - this will be determined by productivity, the rate of inflation in that country compared to the rest of the world, and the exchange rate.
- The non-price competitiveness of that country's exports - this is dependent on factors like quality, reliability, after-sales service and so on.
On the following pages, we look in more detail at changes in the balance of payments and what we can do to correct them. We consider the following topics in detail:
- Consequences of deficit/surplus
- Methods of correction
- Consequences of capital account deficit/surplus
- Marshall-Lerner condition