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Difficulty: EasyBalance of Payments Disequilibrium and Adjustment Measures

A country experiencing a persistent deficit in its balance of payments decides to adopt an expenditure-switching policy to achieve equilibrium. Which of the following actions directly represents an expenditure-switching measure?

  1. Devaluing the domestic currency to make exports cheaper and imports relatively more expensiveAnswer
  2. B
    Increasing domestic income tax rates to reduce total consumer spending power
  3. C
    Removing import duties and tariffs to increase overall foreign trade volume
  4. D
    Recording short-term foreign investment inflows under the current account schedule

Answer

Devaluing the domestic currency to make exports cheaper and imports relatively more expensive
Devaluing the domestic currency makes local goods cheaper to foreign buyers and imports more expensive to domestic consumers. This alters relative price signals, encouraging consumers to switch expenditure away from foreign imports and toward domestic production, thereby correcting a balance of payments deficit.

Step-by-Step Solution

1
Identify the goal of expenditure-switching policies.
Expenditure-switching policies aim to alter the relative prices of foreign goods compared to home-produced goods.
This redirects or 'switches' domestic and foreign demand toward domestically manufactured products, boosting exports and curbing import demand.
2
Evaluate the options against expenditure-switching vs. expenditure-reducing definitions.
Currency devaluation directly changes price ratios between domestic goods and foreign goods, fitting expenditure-switching.
Tax hikes reduce general aggregate demand (expenditure-reducing), while removing tariffs increases import consumption.

Key Concept

Expenditure-Switching Adjustment Policies
Estimated Time:45s
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Topics

Balance of Payments Disequilibrium and Adjustment Measures

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