Balance of payments problems - HL Only!!!!!
HL Syllabus only: Discuss the implications of a persistent current account deficit, referring to factors including:
- foreign ownership of domestic assets,
- exchange rates,
- interest rates,
- international credit ratings and
- demand management.
- lower domestic consumption and investment, as well as the
- appreciation of the domestic currency and therefore reduced export competitiveness.
The balance of payments can cause problems for policy makers when there is either, a persistent deficit, or persistent surplus in one aspect of the Balance of Payments.
A large deficit (or even
surplus) may need policies to correct it - particularly in the medium
to long term. To a large extent, the growth of imports and exports will
depend on the relative levels of economic growth domestically and
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 at a faster rate than growth of GDP. This will tend to lead to a Current Account 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 growth. This could lead to a Current account surplus.
- Changes in demand for exports and imports in response to price changes (relative inflation rates) 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 Current Account 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.