Examkin

Question

Difficulty: EasyBalance of Payments Disequilibrium and Adjustment Measures

To correct a persistent balance of payments deficit, a central bank decides to adopt an expenditure-reducing monetary measure. Which of the following actions directly achieves this objective?

  1. Raising the bank rate to contract credit and lower total domestic demandAnswer
  2. B
    Lowering the cash reserve ratio to expand liquidity available to commercial banks
  3. C
    Subsidizing local manufacturers to promote export substitution over foreign market entry
  4. D
    Reclassifying foreign direct investment inflows from the financial account into the current account

Answer

Raising the bank rate to contract credit and lower total domestic demand
Expenditure-reducing monetary policies aim to dampen aggregate domestic demand. Raising the bank rate leads to higher interest rates across the banking system, restricting credit creation and reducing general spending, which in turn reduces expenditure on imported goods.

Step-by-Step Solution

1
Identify the goal of the policy measure
The goal is to correct a balance of payments deficit via an expenditure-reducing monetary policy.
Expenditure-reducing policies target aggregate domestic expenditure to curb total spending, including spending on foreign goods.
2
Evaluate the monetary policy tools presented
Raising the bank rate is a contractionary monetary policy that discourages borrowing and dampens consumer and investor spending.
Higher interest rates reduce disposable income and loan availability, leading directly to reduced import spending.

Key Concept

Expenditure-reducing policies for Balance of Payments adjustment
Rate this question

Topics

Balance of Payments Disequilibrium and Adjustment Measures

More questions from this topic