Balance of Payments Disequlibria

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Balance of payments disequilibrium occurs when deficits are unmanageable and cannot be matched by inflows over a period of time.

Disequilibrium occurs when a current account surplus is not enough to cover a financial account deficit (or vice versa).

Many factors can cause the current account to be in deficit:

In the short term, if consumer demand is strong (during economic booms)  and if imports have high income elasticity of demand, import payments will increase.  Alternatively, if the currency is overvalued this will result in low export payments and high import payments (assuming the combined PED of exports and imports is greater than 1).  If there is a recession overseas, demand for exports will fall and export receipts will fall.

These are not serious, as recessions and booms will not last forever.  If subject to market forces, the currency should fall in value (due to lower demand for exports) and make exports more attractive, restoring equilibrium.

In the long term, deficits can occur if countries are unable to invest in capital goods.  This is particularly problematic in developing countries, with poor credit ratings.  As a result, the country cannot progress production into the secondary and tertiary sectors.  They will be limited to cheap, primary exports and have to buy secondary and tertiary products at higher prices.  A lack of productivity and innovation will cause a country to lose its international competitiveness.

These are more serious.  It can be difficult for developing countries to find the money to invest in capital goods, meaning they will be stuck, unable to improve production.  A loss of long-term international competitiveness may be hard to repair and lead to long term current account deficits.

A balance of payments deficit will cause Aggregate Demand to decrease, as money is being…


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