Fixing BOP Defecit

Macroeconomic stragegies for fixing a BOP defecit

(30 marks)

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  • Fixing BOP Defecit
    • Decrease Expenditure
      • Monetary Policy
        • Interest Rates
          • Increasing interest rates will increase MPS and decrease MPC so spending on imports (I) will decrease
          • However, less borrowing means less consumer expenditure so C will decrease and so AD will decrease, stunting economic growth
        • Quantitive Easing
      • Fiscal Policy
        • Tax
          • Increasing tax rates will gain more tax revenue and so consumer expenditure on imports will decrease and government will have more tax revenue
          • However, increasing tax rates too much will cause a decrease in tax revenue as the wealthier choose to use tax avoidance strategies due to more payoff
        • Spending
          • Government can decrease their expenditure on the economy in or order to decrease magnitude of defecit (E.g degrease in benefits)
          • However, Decrease in government spending will reduce AD and so reduce economic growth, could however decrease in inflation, Depends on position of AD on LRAS
    • Overt Protectionism
      • Tarrifs are taxes on imports
      • A tarrif will raise the price of imports, decreasing the domestic demand for impoerts and so decrease the quantity, this will cause a fall in value of total imported goods and so M will decrease
      • However, one problem with this is that there will be an increase in welfare loss (as shown by the diagram)
      • Another problem is that tarrifs could conflict with trade bloc agreements such as the EU and so tariffs imposed could lead to removal from the trade bloc (stunting economic growth)
      • However, Imposing a tariff could lead to a heavy retaliation tariff from that country and so first country will see fall in X, no better off in LR
    • Currency Depreciation
      • Imports
        • A depreciated currency will cause imports to be more expensive decreasing demand, and so Imports will decrease
      • Exports
        • A depreciated currency will cause exports to appear cheaper, so increase in demand will increase quantity, so X will increase
      • "Marshall-Lerner Effect" for the change in price to have an affect the sum of the Elasticitites must be greater than 1 (i.e change in BOP depends on elasticity of X and M
      • Delay  in change in BOP due to time delay of demand. Initally no change in demand, but more expensive imports and cheaper exports means initial fall in BOP, but in LR should improve


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