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Difficulty: HardBalance of Payments Disequilibrium and Adjustment Measures

The balance of payments statistics of a country show visible exports of 420million,visibleimportsof420 million, visible imports of 580 million, net receipts from invisible trade and official transfers of 60million,andnetcapitalinflowsof60 million, and net capital inflows of 40 million. What is the current account balance, and which expenditure-switching measure can be implemented to address this disequilibrium?

  1. Deficit of $100 million; Devaluation of the domestic currencyAnswer
  2. B
    Deficit of $100 million; Increasing the central bank discount rate
  3. C
    Deficit of $60 million; Imposing protective tariffs on foreign imports
  4. D
    Surplus of $100 million; Reducing commercial bank cash reserve requirements

Answer

Deficit of $100 million; Devaluation of the domestic currency
The Current Account Balance is computed by adding net invisible receipts to the visible trade balance (420M−420M - 580M + 60M=−60M = - 100 million), indicating a deficit of $100 million. Capital inflows belong to the capital/financial account and are excluded. Devaluation is an expenditure-switching policy because it alters relative prices to shift expenditure from foreign imports to domestic substitutes.

Step-by-Step Solution

1
Calculate the Balance of Visible Trade
Visible Trade Balance = 420million(Exports)−420 million (Exports) - 580 million (Imports) = -160million(Deficitof160 million (Deficit of 160 million)
Visible trade balance includes only tangible merchandise trade exports and imports.
2
Calculate the Current Account Balance
Current Account Balance = Visible Trade Balance (-160million)+NetInvisibleReceipts(160 million) + Net Invisible Receipts ( 60 million) = -100million(Deficitof100 million (Deficit of 100 million)
The current account comprises visible trade, invisible trade (services), and net transfers. Capital inflows are recorded under the capital/financial account and must be excluded.
3
Identify the appropriate policy category and measure
Expenditure-switching policy = Devaluation of domestic currency (or tariffs/quotas)
Expenditure-switching policies aim to redirect demand from foreign goods to domestically produced goods by altering relative prices. Devaluation directly lowers export prices in foreign currency and raises import prices in domestic currency.

Key Concept

Calculation of Balance of Payments Current Account and Classification of Adjustment Policies
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Topics

Balance of Payments Disequilibrium and Adjustment Measures

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